(CORRECTED)MNI INTERVIEW: ECB Communications Errors Risk Market Selloff

(Corrects Stefan Gerlach's status in the Governing Council)

The European Central Bank must make its language clearer if it is to retain the confidence of markets, a former attendee at Governing Council meetings told MNI, warning that communication errors could prompt a blowout in peripheral bond spreads if rates continue to rise steeply.

December’s guidance by President Christine Lagarde suggesting at least two half-point hikes to come after that month’s increase by the same amount was inconsistent with the Governing Council’s stated commitment to data-dependency, former Central Bank of Ireland deputy governor Stefan Gerlach said in an interview.

“It’s contradictory to say that ECB will be driven by the data, but then say that it will raise rates three times by 50 basis points. There is, plainly, concern among financial market participants about the inconsistencies in [Lagarde's] communication,” Gerlach said.

His remarks chimed with recent comments by Executive Board member Fabio Panetta, but Gerlach said that Governing Council doves are unlikely to contest the current "draconian" rate path until new Eurosystem staff growth and inflation projections are available in March.

“They have said so much now that they essentially have to continue to raise rates by 50 basis points [from December to March]. Anything else will look as if they are backtracking and will further erode credibility. So it’s unsettling when policy is managed according to a constraint on policy you yourself set previously.

MARCH PROJECTIONS KEY

“The projections in March will be very important,” he continued. “If they are weak, they offer the ECB an opportunity to backtrack on Madame Lagarde’s pre-announced course, and conversely if they are strong.” (See MNI SOURCES: ECB Doves Eye Smaller Hikes As Inflation Falls)

December also saw the ECB decide to reduce reinvestments from its asset purchase programme by EUR15 billion per month from March 2023, with a detailed announcement on how the bank will shrink its balance sheet set for next week.

However Gerlach - now Chief Economist at EFG Bank in Zurich - doubted how much more information policymakers could give, with any communications miss-step on quantitative tightening likely to have consequences for more heavily-indebted member states.

“They will have to say something, since they have promised to do it. That wasn't necessarily so wise. This is, I think, in many ways a more important announcement than the interest rate announcement on its own,” he said. “I am worried what could happen to bond yields in the periphery of Europe if it is communicated badly or is seen as too rigid by the markets. That is a key issue.”

One option would be to announce the Council’s intention to reduce its corporate debt holdings. Another, though not important for monetary policy, would be to redirect reinvestments from the stock of its remaining debt into green bonds, Gerlach said.

“Central banks can always say that they do not want to hold much private debt on their balance sheets. This is for the markets to deal with. What they strategically would need to signal is that they are not going to be selling Italian, Portuguese, Spanish government bonds into a weakening market. We will see how it is phrased. This is one of the things that I worry was not well thought through.”