ECB Insight: No Switching of Gears Yet as Lagarde Flags July Hike and Leaves September Unclear

15 June 2023

By David Barwick – FRANKFURT (Econostream) – The European Central Bank on Thursday delivered as expected by Econostream and many others, with President Christine Lagarde leaving no doubt that monetary tightening was set to continue beyond the latest 25bp hike.

To recall, the baseline scenario of our pre-meeting assessment from Tuesday was ‘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.’

‘Are we done?’, she asked today rhetorically. ‘Have we finished the journey? No. We’re not at destination. Do we still have ground to cover? Yes. We have ground to cover.’

‘And I can even go further than that’, she continued. ‘I can tell you that barring a material change to our baseline, it is very likely the case that we will continue to increase rates in July … and this is so because we are determined to reach our target in a timely manner and to continue to apply the principles that we have applied today: data-dependency, the three elements of the reaction function, and moving meeting by meeting.’

The ECB is ‘not thinking about pausing, as you can tell’, she added.

Lagarde implicitly failed to rule out yet another increase in borrowing costs after the summer holidays by resolutely declining to speculate about where the hiking cycle would end.

‘I don’t want to comment about the terminal rate’, she said. ‘We will know when we get there. Because it is not what is driving our analysis and our deliberations.’

Indeed, she even suggested that the Governing Council could still be sufficiently far away from ending the tightening process as to see no need yet to even entertain such a distant eventuality.

‘[I]n terms of … having to pause or having to skip, as I said, number one, we have not discussed it at all, and we have not begun thinking about it, because we have work to do’, she declared.

At Econostream, we see Lagarde’s performance as entirely consistent with the rhetoric that has been emanating from the ECB for some time, which is precisely what led us to be fairly confident of today’s outcome in the first place.

We continue to take the view that the ostensibly unyielding commitment to open-ended hiking is motivated to a significant extent by what we have termed ‘the desire to discourage markets from overly dovish expectations’. Such a motive has a shelf life whose end is nearing.

To be sure, with a 25bp hike in July baked into inflation projections with which, as Lagarde said today, ‘we are not satisfied’, leaving the hawkishness dialled up still remains appropriate.

However, whilst it would be foolish at this early date to actually rule out a final hike in the waning days of the summer - i.e., to think that 27 July will bring an end to the tightening - we suspect that the ECB could be willing to engage in a game of chicken in which markets are allowed to attach a relatively high probability to a further move until the last moment, only for the ECB to then desist, conceivably invoking the new forecasts to become available on 14 September.

Under the data-driven, meeting-by-meeting approach, leaving the door at least a bit open in July, when there will be no new projections to help illuminate the path forward, to a September hike that never materialises would be perfectly defensible, and the benefit in terms of anchoring expectations could prove an attractive additional argument.

Indeed, we don't necessarily expect the terminal rate, whenever it is reached, to be identified unambiguously as such in real time. Rather, we can imagine under the current uncertainty, in particular about wage developments and fiscal policy, that the ECB might prefer to indicate that whatever level it will have reached at some moment could be the terminal rate, under the condition that developments do not require that the ECB resume tightening down the road.

That is all in the realm of speculation for now. Still, nothing Lagarde said today, including her suggestion that the terminal rate would not be evident as such ‘we get there’, would exclude this.