MNI SOURCES: ECB Doves Eye Smaller Hikes As Inflation Falls

While 50-basis-point rate increases are set to be the starting point for discussion at the next two European Central Bank meetings at least, more dovish officials are prepared to seize on an expected slide in headline inflation from the spring to argue for a slowdown in the pace of tightening, Eurosystem officials told MNI.

Base effects and easing energy prices could take harmonised consumer price inflation to as low as 2.7% by the end of the year, below the ECB’s current 3.6% projection, according to one source, while noting that core inflation is set to prove stickier, and that the Ukraine war and the effect of China’s reopening from Zero Covid policies could still provide upside shocks.

Slowing headline price increases should take pressure off wage demands, though hawkish officials who insist that more significant tightening will be necessary to reduce inflation to the 2% target will be able to point to easing concerns over recession as energy prices fall back. One prominent hawk, Austria’s central bank governor Robert Holzmann, said on Wednesday that core prices had yet to peak and that rates still had some distance to rise, while another source saw a shift down to 25bp hikes only possible from around mid-year. (See MNI INTERVIEW: Need Strong ECB Hikes For Early CPI Win -Kazaks)

LAGARDE'S 50-POINT GUIDANCE

But more dovish officials expressed discontent with ECB President Christine Lagarde’s explicit December guidance for rates to increase at a 50-point tack several times more.

“We knew that she was going to say that, but we would have preferred a less aggressive tone,” one official said, stressing that the ECB’s stance could still change if the data changes.

“We have a meeting-by-meeting approach. While we have a base case scenario, 50 points, that could change with new data, new information.”

Another official noted that doves will see lower inflation readings as an opportunity.

“Once we get past the peak in headline, I think that the balance of power between the hawks and doves shifts a little bit,” the official said. “As long as the headline is up around 10% the hawks can just keep banging away at it, but once we see that falling to 7% or 6% - even if core remains quite robust at 4 or 5 say – at that point I think that the argument that the hawks can just keep pushing is going to get weaker.”

While a change in the centre of gravity within the Governing Council would not mean an end to hikes, it would mean that “the relentless hawk push is going to be harder to sustain,” the source said.

QT CONCERNS

Doves are also alive to the effect of quantitative tightening, via the reduction in reinvestments of the ECB’s stock of assets, which is initially set at EUR15 billion per month from March.

“Maybe it would have been good to have some communication on QT, on that the impact will be monitored and that could influence rates, but not everyone sees it this way,” a source said. “We think that QT has an impact on monetary policy, therefore on rates, even if we make clear that rates will remain as the main instrument. That would allow some optionality, and would make the message much easier to understand.”

Headline inflation fell to 9.2% last month, and could dip to 6-8% by March or April, officials suggested. Core inflation hit 5.2% in December and is projected to be still above target, at 2.4%, in 2025. The hardest part of the inflation battle might be getting it down to the 2% target from levels around 3%, said another source, a former senior official.

“We are expecting bad numbers for January and February, so the big question is where are we are at the end of March and the beginning of April? It would be great to see in March that the numbers are softening,” one official said.

So far officials are pleased with how markets have responded to their messaging, with investors pricing in a peak deposit rate of about 3.4% by July, but several sources said communications would become more challenging if a reduction in inflation coincides with higher unemployment and sluggish growth, even if the eurozone as a whole avoids outright technical recession.

“Markets already assume [an economic] slowdown,” a source said, adding “We might have in the end to overshoot.”

An ECB spokesperson declined to comment.