MNI INTERVIEW: ECB Peak Rate Likely 3.5-3.75% - Gerlach

The European Central Bank is likely to raise its deposit rate to no more than 4% in a trade-off between hawks wanting to hike further and more dovish officials preferring a lower peak but to maintain it for much longer, former Central Bank of Ireland deputy governor Stefan Gerlach told MNI.

Despite recent hawkish remarks from some national central bank governors, a terminal rate of only 3.5% remains possible, Gerlach said, with the deposit rate increased by 50bps to 3% in March followed by two 25bp hikes in May and June. While hiking above 4% is on the table, this could prove prohibitively risky for a majority of Governing Council members, with a peak of 3.75-4% the most likely hawkish outcome, he said in an interview, in which he also pointed to a 50bp hike by the Swiss National Bank later this month. (see MNI INTERVIEW: ECB Likely To Be Forced To Support Bond Markets).

“There is a trade-off. If the ECB raised interest rates significantly above 4%, they wouldn’t have to keep them there for a long time for the economy to slow. If they kept them at the current level they would have to wait quite some time. So there is a choice. Do you want to have a brief shock treatment, or a more gradual lowering of inflation?” said Gerlach, now chief economist at Zurich-based EFG Bank.

ACCUMULATED TIGHTENING

While evidence has so far been patchy of the effect of accumulated tightening on growth, unemployment, and property markets, despite the ECB having raised rates “sharply and quickly” and talked tough on inflation, Gerlach said this may be about to change.

“There is a fair chance that as time passes the impact of higher interest rates on the housing cycle will become more apparent, and the Governing Council desire to see higher rates will evaporate," he said. “Once those numbers start to change, I could well imagine the Governing Council could change direction rapidly.”

Strong wage increases - a factor the ECB has identified as a main driver of underlying inflation - are unlikely to prevent policymakers from slowing the pace of rate hikes, Gerlach said.

“I don't see wages as necessarily being an autonomous driver of inflation as they were in the 1970s. The structure of the economy has changed too much since then.”

Elsewhere in Europe, the SNB is likely to follow the ECB's lead at its meeting on March 23, after inflation surprised to the upside at 3.4% in February - well above the bank’s target range of 0-2%, Gerlach said.

“The SNB will raise rates, most likely by 50bps, since the ECB has signalled that it will do so and since the SNB will not have another policy meeting until June."

China’s reopening and sliding energy prices will help to prop up European economic activity, Gerlach said. But the positive contribution of growth to upward price pressures will fade, “whereas the effect of higher interest rates on domestic demand data is going to rise. So I think the balance would gradually shift over.”