MNI SOURCES: Both 75, 50BP Still In Play As ECB Readies Hike​

The chances of a 75-basis-point hike at the European Central Bank’s meeting this week have risen, as even more dovish officials recognise the need to take interest rates above 1% by the end of the year to tame inflation, but a smaller 50-bp increase remains on the table, Eurosystem sources told MNI.

While worse-than-expected readings for August inflation and euro depreciation, which pushes up already inflated dollar-based prices of commodity imports, have driven expectations of a bigger increase than July’s 50-bp move, officials confessed that the outcome of this week’s meeting was hard to anticipate, in a very different situation to that in the days of former ECB President Mario Draghi, who was more direct in steering the Governing Council towards what he viewed as the correct path of policy.

“I hear there is a growing clamour for a larger hike,” said one official, adding that his own preference was for consecutive 50-bp hikes in September, October and December. “Personally, I wouldn't object vociferously if the consensus was towards” 75, the official said, though he noted that this might mean slowing the pace of increases to 50 points in October and only 25 in December, potentially blurring the ECB’s messaging.

“We get to the same place, but the idea of a deceleration in hikes may not offer the correct visuals,” the official said.

ON THE FENCE

Another official said his national bank was on the fence as to 75 or 50, though it saw the ECB’s benchmark rate at neutral levels by the end of the year. Support for a 75-bp hike was “soft”, the official added, adding that it would be particularly unwise to allow the exchange rate to unduly influence monetary policy.

“If you get into this game of trying to hike in order to keep the euro stronger, I think it is not a good way to go,” the official said.

The ECB faced an extremely delicate task as it managed not only inflation and soaring energy prices after Russia cut off gas supplies but also a weak euro and a potential recession, the official said.

“This makes the Fed’s job look like a piece of cake - and all of this without even mentioning Italy,” the source said. “I wouldn’t get carried away with hawkish statements.”

The eurozone’s neutral rate is between 1%-2%, according to Bank of France Governor Francois Villeroy de Galhau in a speech last month, while other ECB officials have said it is close to 1% and Slovakia’s Peter Kazimir sees it at about 2%.

The weak exchange rate is the strongest argument for 75 bps, said another official, adding that whatever view president Christine Lagarde takes would have a good chance of prevailing given the Governing Council’s preference for unanimity. She is likely to opt for 50, the official said.
“They're going to dress up this decision for 50 bps with some wording telling you that if inflation is insisting we’ll do whatever it takes - just kicking the can down the road for another 50 bps next time. They have to follow a path.”

LANE SPEECH

But the view of ECB Chief Economist Phillip Lane will also be influential, and, while a speech of his on Aug 29 was widely perceived as pushing back against calls for 75 bps, another source said this interpretation might be mistaken. Lane, commonly regarded as a dove, proposed a larger-than-expected 50-bp hike in July, the source noted.
“You would have expected him to have a more moderate stance, but he came forward with 50 basis points right away,” the official said. “The main point next week is that expectation that we move at all, that we are moving out of zero territory. That will have some implications in itself. We might still need leeway for the winter.”

One former senior ECB official said that 75 bps would be the most appropriate increment, and that staff projections this week will show underlying inflation remaining much too high in 2023, before falling to around 2% in 2024, even as the economy slips into a “mild recession” from the fourth quarter of this year until the first quarter of 2023.

The Jackson Hole speech by Federal Reserve Chair Jay Powell and suggestions that the Fed could raise rates by 1% at its next meeting have helped to make a 75-bp move a possibility, said another source, adding that the ECB would still have to proceed gradually, allowing it to see how the economy responds on a meeting-by-meeting basis.

“At the same time, I don't think there is a huge difference in terms of impact on the economy between 50 and 75,” the source said.

Contacted by MNI, an ECB spokesperson declined to comment.