ECB Insight: No Euphoria, No Victory Lap, No Rate Cut Talk; Lagarde Attentive and Focused

12 December 2023

By David Barwick – FRANKFURT (Econostream) – We see the key outcome of this week’s European Central Bank Governing Council meeting as a distinct but carefully measured and limited distancing from the hawkish tone of six weeks previously.

That is, there will be a clear acknowledgment of further progress made in returning to price stability, but one should expect no declaration of victory, no endorsement of what the ECB regards as excessive dovishness on the part of markets, and no encouragement of imminent rate cuts.

Interest rates will still need to be ‘maintained for a sufficiently long duration’, and discussion of cuts is still likely to be branded as premature, even if this time ECB President Christine Lagarde could at least recognise à la Banque de France Governor François Villeroy de Galhau last week that the issue ‘may arise in 2024, but not now.’

She may also explicitly confirm that the terminal rate appears with high probability to have been reached, but if it comes at all, then this truism will surely be tempered by references to still-elevated uncertainty and the assurance that the ECB would not hesitate to tighten further if data indicated a need. Doors will not be slammed shut in this regard.

Could the ECB now say that its future decisions will ensure that policy rates ‘remain at’ – rather than ‘will be set at’ - sufficiently restrictive levels for as long as necessary? Yes – this would not really tie anyone’s hands if disinflation stalled. For which reason the change is no more necessary than July’s retirement of ‘will be brought to’, though it would constitute a clear nod to evolving circumstances.

The idea that the ECB overall would continue to cling to its previous degree of hawkishness makes little sense to us, especially in light of the comments made days ago by Executive Board member Isabel Schnabel.

Schnabel is the most hawkish member of the Executive Board, her stature similar to that of Chief Economist Philip Lane, and we attach a lot of weight to her dovish shift, especially in view of the timing.

When in the last Executive Board interview before the pre-meeting quiet period she gushes that the faster-than-expected decline of underlying inflation is ‘quite remarkable’ and that[a]ll in all, inflation developments have been encouraging’, it is likelier that she is reflecting dominant thinking at the ECB than on the regular occasions when she stakes out uniquely hawkish positions.

We hardly expect Lane to stem the dovish tide. A bit, perhaps, given his previous insistence that the ECB has to stay the course while awaiting wage data available only well into next year. Even the weaker-than-expected activity of late shouldn’t change this, as this is no guarantee of well-behaved wages in a worker’s paradise like Europe.

The flavour of the day is thus the dawning realisation that just because inflation surprised to the upside two years ago, it doesn’t always have to. Previously, this understanding seemed to be missing, the failure to foresee the inflation that led to the hiking cycle having resulted in a sort of tunnel vision.

Exultation would be entirely out of place with spot inflation still so clearly above the ECB’s target and inflation risks still not assessed as tilted to the downside on balance. Consider Lagarde’s own most recent words:

‘Looking ahead, we expect the weakening of inflationary pressures to continue, even though headline inflation may rise again slightly in the coming months, mainly owing to some base effects’, she said on 27 November. ‘However, the medium-term outlook for inflation remains surrounded by considerable uncertainty.’

As a summary of the inflation outlook, this remains uncontroversial, as do other aspects of her and others’ assessments, such as the concern that wage and profit developments or geopolitical events could thwart the restoration of price stability.

All this argues in favour of not exceeding an incremental change in the rhetoric – more drift than shift, more progression than inflection point.

And there is yet another factor the ECB will have in mind that suggests restraint. The most unvarnished wording of this point came from National Bank of Belgium Governor Pierre Wunsch on 20 November.

‘Is it a problem if everybody believes we’re going to cut?’, he asked. ‘Then we have a less restrictive monetary policy. And I’m not sure that then it’s going to be restrictive enough. So it increases the risk that you have to correct in the other direction.’

The ECB simply doesn’t have enough certainty to risk giving rise to the impression that its work is done.

We like what Lagarde said on 21 November and would not be surprised to see it used as a blueprint for her messaging on Thursday.

‘[W]e are in a phase of our policy cycle which I would characterise as being “attentive and focused”’, she said.

‘We need to be attentive to the different forces affecting inflation: the unwinding of past energy shocks, the strength of monetary policy transmission, the dynamics of wages and the evolution of inflation expectations', she continued. 'And we need to remain focused on bringing inflation back to our target, and not rush to premature conclusions based on short-term developments.’

As for other issues potentially on Thursday’s agenda, we think the favourable market environment and other reasons discussed by us last week make a discussion of QT somewhat likelier to start than not.

Given apparently broad willingness to upend current PEPP forward guidance, it is not excluded that there would be no need for the discussion to extend beyond December. However, at this point it matters little, as the implementation of a final decision will in any case not come until 2024.

Consideration of minimum reserve requirements appears destined to wait for now.