By David Barwick – FRANKFURT (Econostream) – A mere eleven days ago, a well-known news agency saw a June hike by the European Central Bank as becoming less likely. The opposite is true, and the only interesting case anymore with respect to June 11 is one in which the Iran conflict ends soon, the resolution looks durable and forward energy prices fall far enough, fast enough, to influence the new macroeconomic projections.

The likelihood of this rosiest of all scenarios – which at this point would not even guarantee a hold – is receding daily, and in every other case, a 25bp hike is probably inescapable.

Not, however, because the ECB is approaching the meeting with the certainty central bankers prefer when changing policy. Beneath the emerging resolve lies a continuing reluctance to impose tighter monetary policy on a weak economy.

But as the shock persists, the case for waiting is fading, while the arguments for a modest preemptive move have migrated well beyond the hawkish corner of the Governing Council. The debate is not so much a contest between hawks and doves as it is a test of how long a supply shock can be looked through before looking through it becomes a credibility risk.

It is in this context that we consider recent comments from officials who are anything but card-carrying hawks: Central Bank of Malta Governor Alexander Demarco, Bank of Finland Governor Olli Rehn and Bank of Greece Governor Yannis Stournaras have all drawn a line from the ECB’s credibility to the possible need to raise rates if the shock persists and inflation expectations deteriorate.

This is the point on which the June case rests. The ECB does not need to conclude that a higher oil price mechanically requires higher rates, but only that the shock has lasted long enough, spread widely enough or affected expectations sufficiently to make further inaction look more dangerous than a 25bp increase: a lower bar than certainty, but high enough.

ECB President Christine Lagarde has been careful not to pre-commit, and some of her recent caution left room for renewed doubts about the ECB’s willingness to act. Her most recent remarks, in contrast, underscore the likelihood of a hike: on Friday, she echoed incipient concerns regarding inflation expectations and observed that “even if the crisis were resolved now … there would be lagging effects.”

June does not need to bring certainty about any of this, just enough evidence that April’s “active waiting” has done its job. The cumulative signal from recent public comments and background conversations is that waiting has become harder to justify unless the shock turns materially more benign very soon.

Even the importance of the fresh staff projections should not be overstated. These will probably support action, but the political facts around the conflict and energy flows via the Strait of Hormuz matter more.

Nor should the March scenarios be treated as a simple traffic-light system in which “adverse” means hike and “baseline” means hold. The scenarios were multi-year paths based on assumptions that may no longer correspond neatly to the current situation, so what matters is whether the new baseline and surrounding scenarios show enough inflation persistence, pass-through risk and expectations pressure to make a hold look too relaxed.

On current evidence, that appears likely.

But a June hike would also help the ECB avoid a worse problem later. If the Council waits again and expectations continue to drift up, it may find itself under pressure to do more than 25bp at a subsequent meeting. Even hawks have signaled discomfort with such a large step, which would convey not merely that the ECB is responding, but that it is catching up.

A small June increase can therefore also be understood as insurance, even if policymakers reject the label. It would mean the ECB is trying to preserve the option of moving gradually rather than discovering later that gradualism has become insufficient.

This is where credibility enters the argument, with the risk not that markets doubt the ECB’s willingness to deliver one 25bp hike. It is that households, firms and wage setters may begin to doubt that it will stop a supply shock from becoming a broader inflation problem.

When expectations across the nearer and intermediate horizons are rising together, the comfort from a still-anchored five-year measure becomes less complete. It is too soon to panic, but not to recognize that waiting for obvious de-anchoring would be waiting too long.

That still does not make the decision easy; hence the reluctance we noted above.

Compared to 2022, growth is weaker, investment remains poor and the labor market, while still resilient, is less obviously overheated than it was during the post-pandemic reopening. The global nature of the current shock may also mean weaker external demand, not just higher European energy costs.

The implications for the sacrifice ratio are clear, and the ECB cannot assume that another round of tightening would impose the same limited real-economy damage as the last one. It would be surprising if the economy were not now more vulnerable to higher rates.

This non-trivial concern explains why the ECB still hasn’t moved. Policymakers do not want to cause unnecessary harm, and they certainly do not want a 2011-style mistake: raising rates into a shock only to reverse course when the economy cracks.

But a 25bp June hike would not by itself constitute a full tightening cycle. It would not oblige the ECB to hike again in July, and it would not even make a September move automatic – anything can happen between now and then. It would in essence be a response to the persistence and credibility risks already visible, not a promise to keep going regardless of the data.

Indeed, July looks like a dubious fallback. If the ECB has enough evidence by June, then June is the natural point to act. If it does not, July is unlikely to offer a dramatically cleaner picture unless developments deteriorate sharply or the ECB uses June to prepare markets explicitly for a later move.

In our view, September is a more plausible date for a second step, but a second step is not a foregone conclusion anyway. The ECB would still need to see enough in expectations, wages, underlying inflation and the real economy to justify adding to the move.

June’s decision, therefore, is not the start of a declared hiking cycle. It is more likely to be a reluctant credibility hike, delivered with careful language designed to avoid implying that further moves are pre-programmed.

That would be consistent with the public comments of officials who have emphasized both sides of the dilemma. Rehn has kept open the need to act to protect credibility, while still pointing to the absence so far of clear second-round effects. Demarco has suggested a June move may be needed, but not a large departure from 2%. Others, including Bundesbank President Nagel, Latvijas Banka Governor Mārtiņš Kazāks and outgoing Eesti Pank Governor Madis Müller, have been more explicit that conditions are moving away from the baseline or that a fast positive resolution would be needed to avoid higher rates.

The ECB is likely to hike because the shock has lasted, because expectations show enough warning signs, because credibility is becoming part of the reaction function and because waiting may increase the risk of a larger move later.

It is also likely to insist that this does not settle September, let alone define a new cycle.

If the ECB raises rates in June, as we expect, it will not be because policymakers have suddenly become comfortable with the growth outlook or indifferent to the possibility of a policy mistake, but rather because doing nothing will look like the larger mistake.