ECB Insight: Default Option of 25BP Likely to Prevail as Data Fail to Meet Standard for 50BP

2 May 2023

By David Barwick – FRANKFURT (Econostream) – Directly following the European Central Bank Governing Council’s last monetary policy meeting, we inclined to the opinion that another 50bp hike in May was somewhat likelier than the only other reasonable alternative of 25bp.


This view was motivated by the stated determination of the ECB to do more, by the somewhat hawkish tone of the 16 March decision and press conference (in particular the apparent failure to be swayed by banking sector turbulence) and not least by the intention, expressed to Econostream, of one normally not terribly hawkish Council member to support 50bp in May as well.


With the renewed bout of market turmoil on 24 March, our assessment started to evolve to favour a smaller step this month. The preference to decelerate of some Council members who were fully on board with the big hikes of the recent past supported this evolution; in this regard, we note in particular Banque de France Governor François Villeroy de Galhau, who has steadily insisted that hikes could now become more ‘limited’ in size.


We see the latest data as having confirmed a 25bp rate increase as the likelier outcome, mainly because this has become the default option such that any other move would have had to meet a fairly rigorous standard of proof to prevail.


Not an impossible standard, though; reasonably alarming new information could have been sufficient to convince enough Council members to support going big yet again. That, we believe, is clear from our member-by-member review last week of monetary policymakers.


Under the circumstances, however, we think the bar for anything but the default option of 25bp has not been reached. Indeed, the data may even call into question the extent to which the ECB has to do what National Bank of Belgium Governor Pierre Wunsch noted in a recent Econostream interview could be appropriate: accompany the smaller hike with hawkish language.


We suspect great hawkishness – as opposed to a measured dose - may be seen as an unnecessary counterpoint to a 25bp hike. Instead, it would not be surprising if, for example, ECB President Christine Lagarde were to note the increasing importance of considering the balance of risks between tightening too much and tightening too little.


Of course, the ECB will be careful against appearing too relaxed, and Lagarde can hardly avoid pointing out the various inflation risks and making clear that with all measures still too high, the ECB’s job is not yet done. We don’t see pressure on her to go much further than that.


The ECB is unlikely to stray from its data-driven, meeting-by-meeting approach to setting policy in any event, so that its hands will remain untied whether or not post-4 May data continue to confirm that the tightening cycle is nearing an end.


Otherwise, we imagine that not much news will emerge from this occasion. We don’t see why the ECB would already now need to make a firm decision about the post-June pace at which it will continue to reduce its balance sheet.


Moreover, with the data on balance supporting a deceleration of the pace of tightening, a compromise involving QT to appease the hawks, who have less ammunition than they might have otherwise had, has become a tad less critical. At any rate, Council members, including hawks, have expressed little desire to, as Wunsch put it, ‘mix that discussion too much with the rate hikes’.


This by no means precludes some confirmation from Lagarde that the reduction of the balance sheet is proceeding smoothly, and she could reinforce expectations of an acceleration from July.