ECB Insight: On Hold, Not on Pause, but Still With a Hawkish Bias

24 October 2023

By David Barwick – FRANKFURT (Econostream) – To describe the outcome of this week’s European Central Bank Governing Council meeting as a pause might inadequately capture the firmness with which policymakers are actually on hold at the moment, meaning that a rate move is virtually excluded.

We also don’t think that President Christine Lagarde’s post-meeting rhetoric is going to encourage the idea that monetary authorities have only really paused in the sense of regarding their policy tightening as a work in progress to be resumed come December with yet another hike.

Why should she, against a backdrop of great uncertainty, with the pass-through of previous tightening continuing apace, growth seen daily to be weaker than projected and inflation more or less consistent with expectations? And which of the Governing Council members, whose recent comments have been collected here, sounds like he thinks October is really just a brief ‘pause’?

For at least the time being, the emphasis is unmistakeably on duration, backed up of course by a willingness to act if developments clearly require it, a readiness Lagarde is also likely to underscore.

That implies that the bias is going to remain somewhat hawkish, though we see no reason for it to be exaggeratedly so. Even if the rather dovish chief economist, Philip Lane, has emphasised that rate-setters ‘are going to need to watch the labour market for quite a while’ to feel comfortable that wage developments won’t thwart efforts to restore price stability.

The 14 September press conference is thus not the worst blueprint for President Christine Lagarde’s post-meeting rhetoric on Thursday.

However, that only one questioner will be interested in where things stand with respect to the unwinding of the ECB’s balance sheet, as was the case six weeks ago, is unlikely.

Speculation is rampant, also because Governing Council members themselves are publicly questioning the ongoing acquisition of assets under a programme set up to mitigate the impact of the pandemic, at a time when other policy instruments point in the opposite direction.

Precisely the desire of her colleagues to open such a discussion, in conjunction with the likely availability of time to accommodate this desire, leads us to believe that the subject will make it onto the agenda in Athens, where this meeting is taking place.

But – despite the broad support for such a discussion made clear in our recent survey of Council members – we don’t expect any major decisions to emerge.

Lagarde herself has of late consistently avoided encouraging the speculation about an acceleration of QT that would potentially start with a revision of the PEPP forward guidance. That reticence should stand her in good stead on Thursday.

Indeed, the Executive Board appears less enthusiastic on average than the Governing Council as a whole, having remained remarkably mum on the subject. In consequence, it would be at least surprising if the ECB now rushed this through just because it happened not to be hiking interest rates on this occasion.

Given the complexity of the issue and the related need to discuss the entire operating framework, we find unlikely the idea that the Council would again indulge the hawks and come to any conclusion permitting Lagarde to do more than say, ‘We're looking at it’ and perhaps make some reassuring statement of principle.

That bond yields are higher globally and in particular as regards Italy, and that a geopolitical risk in the Middle East has apparently materialised, makes it to our mind all the more improbable that the ECB will see it as a good time to tempt fate and test markets.

Whilst less disposed to rule out a tweak to the minimum reserve requirements, our scepticism about a decision on this front is similar, and to this reasoning we can add that various Council hawks also appear to want to go slow here.

As Executive Board member Isabel Schnabel observed, ‘we are currently discussing the design of our future operational framework for monetary policy implementation. As long as we do not know the role that minimum reserve requirements will play in this new framework, we should be cautious about making any far-reaching decisions.’

That sentiment was echoed by Banque centrale du Luxembourg Governor Gaston Reinesch, while National Bank of Belgium Governor Pierre Wunsch said he didn’t ‘see any strong argument for using movements in the reserve requirements when we still have this huge portfolio that we can reduce.’

This meeting of the Governing Council is the last to include retiring Banca d’Italia Governor Ignazio Visco, the first such gathering with him having been 12 years ago. Two days into his first mandate, the Council decided to cut rates by 25bp, even though, as newly minted ECB President Mario Draghi noted, ‘inflation has remained elevated and is likely to stay above 2% for some months to come’.

Lagarde on Thursday could easily echo Draghi in saying, as he did at the time, that ‘[t]he economic outlook continues to be subject to particularly high uncertainty and intensified downside risks.’ But the sentiment that drove the Council to cut rates then, namely the expectation that ‘price, cost and wage pressures in the euro area should also moderate’, is today more akin to a slender hope that can only justify measured vigilance.