ECB Insight: Rhetoric Suggests Door Should Stay Open to Uncertain Amount of Further Tightening

13 June 2023

By David Barwick – FRANKFURT (Econostream) – We have no difficulty excluding the possibility of the European Central Bank Governing Council reaching any other monetary policy decision this Thursday than the one it has amply flagged of another 25bp rate hike.

The more interesting question concerns its willingness to stray from relying on the data-dependent, meeting-by-meeting nature of setting policy as it becomes less easily deniable that beyond June, the number of hikes left in the current tightening cycle is unlikely to exceed two and may not even reach that.

Unlike many observers, we don’t see that the ECB would have much to gain from switching gears and making it clear that July or any other particular month is the end. We have for some time ascribed a meaningful portion of Council messaging to ‘the desire to discourage markets from overly dovish expectations’, as we have referred to it in the past, and think it makes more sense to maintain this attitude for a little while longer.

To be sure, the ECB is rapidly approaching the inflection point at which it will only be logical to embrace dovish expectations. But even with Thursday’s additional 25bp of tightening and with the mostly encouraging inflation-related data of late, the ECB is unlikely to communicate an exact date for reaching that point, a date that may only be apparent in the rearview mirror anyway.

Any other outcome would leave us wondering why, in the run-up to this monetary policy meeting, Council members of all stripes chose not to do a better job of laying the groundwork for a pivot.

One need only consider the most recent comments of policymakers such as ECB President Christine Lagarde. ‘The latest available data suggest that indicators of underlying inflationary pressures remain high and, although some are showing signs of moderation, there is no clear evidence that underlying inflation has peaked’, she said just over a week ago.

Or Executive Board member Isabel Schnabel. ‘A peak in underlying inflation would not be sufficient to declare victory: we need to see convincing evidence that inflation returns to our 2% target in a sustained and timely manner’, she declared less than a week ago. ‘We are not at that point yet.’

Whilst Chief Economist Philip Lane has lately been given to diffusing optimism about prospects for disinflation, he has not cast doubt directly on expectations of at least some further tightening. More generally, less hawkishly inclined Council members seem remarkably willing to support an undefined number of additional moves.

For example, ECB Vice President Luis de Guindos on 1 June said, ‘A big part of the journey has been done but there is still the last stretch.’ Executive Board member Fabio Panetta the following day said, ‘My intuition suggests that we have not reached the end of our rate-hike cycle, though we’re not far away from it.’

And it is not just at the level of the Board that this sentiment appears to dominate, with Banco de España Governor Pablo Hernández de Cos saying on 29 May, ‘We are probably closer to the end, but in any case, the assessment we make at this moment is that we still have some way to go.’

Even Bank of Greece Governor Yannis Stournaras allowed last month that ‘we can't say as of now whether we will have one or two more increases.’

The ECB has thus been decidedly unwilling to usher in the end of hiking. The updated forecasts – which have the greatest potential to alter the course of things – seem unlikely to change that.

Near-term inflation outcomes and ongoing related concern about expectations, coupled with elements of longer-term prospects such as wage developments and fiscal policy, are all probably inconsistent with a significant relaxation of medium-term projections. Added to which, of course, must be a reluctance on the ECB’s part to make another misstep because of undue optimism based on flawed models.

So, with even the doves as of mere days ago having apparently still been willing to play along with the idea that the precise terminal rate remains an open question, we think that Lagarde could conceivably but not necessarily appear to favour the idea of only one more hike, but will in any case leave somewhat unclear the number of steps left in the journey.

In a nutshell, it is uncertain when the terminal rate is to be reached, or at least, that is what the ECB has prepared observers for and is therefore what we expect.

Our baseline scenario is thus that Lagarde keeps alive the data-dependent, meeting-by-meeting approach, indicates at least a fairly high likelihood of a July move; and does not exclude further action in September, contingent on developments.

None of this is to say that she cannot note the progress that has been made, that there is very cautious optimism about inflation prospects, that the impact of monetary tightening is increasingly being felt, that the risks of going too far are increasing; that hiking is almost over; and so on.

Indeed, her language may on balance support a baseline scenario limited to just one more 25bp hike in July. But if she wishes to be consistent with most of what she and her colleagues have been saying recently, then she will not slam the door on the possibility of yet more.