By David Barwick – FRANKFURT (Econostream) – The European Central Bank does not need to feel obliged by markets on Thursday into explicitly validating June rate hike expectations, let alone a 50bp move. But after the latest inflation expectations data and Tuesday’s market reaction, a dovish tone from ECB President Christine Lagarde would fit the moment poorly, even if sounding overly hawkish would also carry risks.

That is the communications challenge if, as we still think most likely, the Governing Council holds rates steady this week: the decision can be cautious, but the tone must convey neither timidity nor pre-commitment.

The latest survey evidence has narrowed the ECB’s scope for comfort. Monday’s SAFE survey showed firms’ selling-price expectations and non-labor input cost expectations moving higher. Tuesday’s Consumer Expectations Survey showed a sharp rise in households’ one-year inflation expectations and a more troubling increase in the three-year measure.

None of this compels an immediate hike. The same surveys also leave room to argue that the ECB should wait for clearer signs of persistence and pass-through: SAFE showed moderated wage expectations and stable medium-term firm inflation expectations, while the CES also pointed to weaker growth expectations and higher expected unemployment. The bank lending survey, also released Tuesday, indicated that banks had tightened credit standards for firms more than expected and anticipated broader tightening in the second quarter.

But the data do make a merely patient tone harder to sustain. They also help explain why markets again became nervous about the possibility of a more aggressive ECB response, including contemplation of a 50bp move if the Governing Council concludes that second-round risks are intensifying.

Lagarde’s task is therefore to convey hawkishness while respecting the ECB’s avoidance of pre-commitment. In practice, that means making clear that the hold is a carefully considered decision to wait for evidence, not a passive preference for looking through the shock amid mounting evidence pointing the other way.

The balance is delicate. Too little hawkishness would make the ECB sound irresolute or complacent; too much would undermine the logic of holding, which is to preserve time for the evidence on persistence and pass-through to become clearer. Lagarde therefore needs to sound alert, not trapped; concerned, not pre-committed.

A simple way to do that would be to say that the Governing Council discussed a hike, a question she is bound to be asked. We suspect a hike will be discussed. Such a discussion may amount to a routine, theoretical exploration of all possibilities rather than serious consideration of a particular policy option. Either way, it would make evident that the decision to hold was not perfunctory. It would also lay the groundwork for a move in June without violating the ECB’s meeting-by-meeting approach or preventing the Council from waiting longer if incoming data prove surprisingly cooperative.

If the discussion was more divided, Lagarde could go further—as she has in the past on repeated occasions—and acknowledge that some members wanted to act without delay. That would be a much stronger signal. It would show that the hold came with a high sensitivity to further bad news.

The difficulty with this is that it cannot be engineered; whereas the topic of a hypothetical hike can easily be introduced, either some Governing Council members will be chafing at the bit to act or they won’t, and we still think this is less likely.

The possibility of a 50bp move, also likely to motivate a question, is delicate but relatively easy to deal with. She need simply say that the ECB does not rule out any appropriate policy response in advance and will decide meeting by meeting based on incoming data. The markets will do the rest.

Another way for Lagarde to sound hawkish would be to give a gloomier assessment of where the economy now stands relative to the March baseline and the ECB’s scenario analysis. In her April 20 speech, she said energy prices had not risen far enough to push the economy “squarely” into the adverse scenario.

The latest SAFE and CES results do not per se change that assessment; the scenarios are defined mainly by the energy price path, the duration of the disruption, uncertainty and propagation mechanisms, not by any single survey release. But the surveys make it easier for her to say that the economy has moved further away from the baseline and that the risk of broader pass-through has increased.

That would be a hawkish signal without being a policy commitment. Lagarde would not need to say that the adverse scenario has materialized, still less that a hike in June is inevitable. She could simply make clear that the latest information has made the risk assessment less benign and that the Governing Council will respond if the evidence of persistence continues to accumulate.

The central question remains whether the shock is becoming persistent through wages, margins, firms’ pricing behavior and inflation expectations. The emerging answer is not yet clear enough to make a hike unavoidable this week, but also not benign enough for Lagarde to sound comfortable. The latest data have strengthened the case for vigilance and weakened the case for an uneventful hold.

For Lagarde, then, the task is to make clear that the Council’s decision not to act yet was rooted in caution that has its limits, not in a lack of resolve.