MNI SOURCES: 100bp Gap Between Hawk-Dove ECB Peak Rates

Hawkish European Central Bank officials want to push rates higher than 4% this year, but doves see the cycle peak as much as 1 percentage point lower, and are preparing to argue for a slowdown in hikes in May after what is likely to be another 50-basis-point increase in March, Eurosystem sources told MNI.

While Dutch central bank chief Klaas Knot argued in an MNI Webcast this week for considering a further 50 basis points in May if necessary, and could find hawish support, others will point to the need to balance the risks of inflation with those to growth as energy prices slide, and highlight the four significant inflation data releases between now and the June meeting. This data, together with the ECB’s March projections, will be key in deciding a potential downshift to a 25-basis-point increment in May, said one highly-placed source at a national central bank.

While some national central banks want to see more than 150 basis points in additional hikes, the centre of gravity in the Council would probably favour a peak rate somewhere between 3% and 3.5%, said the source. Another, with links to one of the more hawkish banks agreed that resistance to taking the deposit rate above 3.5% would be significant.

HIGH FOR LONGER

Several sources emphasised that once the peak is reached that rates could stay there for longer than markets anticipate.

While markets focus on the peak rate, the amount of time that this rate is kept unchanged after being reached is even more important for the economy, another senior official said.

In its February decision, the Governing Council indicated it would raise interest rates significantly at a steady pace and then keep them at levels that are sufficiently restrictive to ensure a timely return to its inflation target.

Forward rates pricing currently indicates that the deposit rate will top at around 3.5% by September, before drifting 10 basis points lower by the end of the year.

“I don't think we go above 3.25% and I certainly can't see anything that, as a collective, pushes us above 3.5%,” one source said. “If neutral is 2%, that’s 150 basis points of restriction,” he said, noting that this would be the tightest setting for ECB monetary policy for decades on that measure. It was even possible the ECB could decide to pause hikes in May, another source from the same bank added.

Sources were agreed that only a significant surprise would blow the ECB off course from 50 basis points in March, and most agreed that a subsequent stepdown to 25 basis-point-increments was likely, but few foresaw much likelihood of a pause. A pause in May could only occur if there was a far greater decline in inflation than expected, one source said.

A more hawkish source saw continuing rapid hikes.

“It could be possible that they will end in summer alongside the Fed, depending on developments in core inflation. That’s not a totally unrealistic scenario - a rate of about 4%, remaining for a period of time until core inflation goes down,” the source said.

The ECB will be concerned to monitor any signs of accelerating wage growth, and will also be wary of inflationary effects of China’s reopening after Covid restrictions, said a former senior banker, predicting that once the peak was attained rates would stay unchanged at least for the rest of 2023.

INFLATION TO SLIDE

For now base effects and much cheaper gas are set to feed through into inflation data.

“Inflation will really start to drop significantly after March and maybe the whole narrative will begin to shift. It will start to be clear between March and June,” said another source, who argued that the ECB has already reached the stage at which the risks of doing too much balance those of doing too little.

A clearer outlook will also reduce market uncertainty over the messaging from the ECB, which has both indicated it intends to hike by 50 basis points in March and that decisions are taken on a meeting-by-meeting basis. (See MNI INTERVIEW: ECB Could End APP Reinvestments In Q3 - Kazaks)

“I think the divisions are bigger than before but we are clearly in the same boat,” the source said. “The manner of referring to both a meeting-by-meeting approach and providing guidance tries to balance this. I think we are in a very delicate moment but as long as the picture clears up in the next months uncertainty will decrease and we won’t seem contradictory.”

An ECB spokesperson declined to comment.