MNI ECB WATCH: Tricky Data Makes Rates Decision A Close Call

With staff macroeconomic projections expected to confirm signs of both sticky core inflation and eurozone economic stagnation, European Central Bank policymakers appear to be split on whether to pause interest rate hikes or increase by another 25 basis points.

As headline inflation eases, more dovish Governing Council members are ready to end the hiking cycle this month, following nine consecutive rate increases, while signaling their willingness to do more if necessary. But hawks are concerned that not enough has been done to bring inflation back to the ECB’s 2% target before 2025, and feel now may be their last opportunity to tighten. (See MNI SOURCES: Hawks Aim For ECB Hike Before Data Ties Hands).

Advocates for a “hawkish pause” believe incoming data points to a turnaround in underlying inflation dynamics, and see holding the deposit rate at 3.75% for the time being as offering greatest optionality.

Recent interventions from Dutch central bank governor Klaas Knot, ECB Executive Board members Philip Lane and Isabel Schnabel, France’s Governor Francois Villeroy de Galhau and Portugal’s Mario Centeno suggest this week’s closed-doors discussions will be particularly exhaustive.

COMMUNICATIONS CHALLENGE

Those in favour of a what many recognise would be likely to be the final rate increase for the cycle feel stopping and starting would prove more damaging, and, while recognising that Europe’s economy has slowed, point to tight labour markets, strong wage growth and uncertainty over future energy supplies.

Both likely outcomes present potential communications challenges, in line with ECB president Christine Lagarde’s remarks at Jackson Hole that there is no re-existing policy playbook to deal with today’s monetary policy challenges.

But a unanimous decision would not be a surprise. The argument that raising faster could allow the ECB to cut sooner has gained little traction even among Governing Council hawks. And despite clear differences in their public pronouncements over recent weeks - especially over whether or not near-term inflation risks remain tilted to the upside - and amid indications that tighter financing conditions are already dampening demand, there is little appetite to go above 4%.

Similarly, while there may be a discussion over whether to pick up the pace at which reinvestments from the ECB’s asset purchase programme are reduced, there is no desire to sell bonds bought under APP. Interest rates remain the main policy lever, meaning talk of a direct trade-off between the two instruments is misplaced.

Some more hawkish members would undoubtedly like an active debate on ending reinvestments from the pandemic emergency purchase programme before the end of 2024 - especially now that Greek sovereign bonds have become eligible for purchase following this week’s upgrade, something that Lagarde is likely to highlight - but it is not a priority.