MNI SOURCES: ECB Doves Wary Of December Push For Hike

The European Central Bank is set to hold its deposit rate unchanged at next week’s meeting, though even some dovish Governing Council voices see a chance of debate over a hike in December if inflation does not fall fast enough, Eurosystem sources told MNI.

While some officials expect a slowing economy to fuel talk of cuts in the deposit rate as early as the first quarter of next year, this will be contingent on inflation continuing to decline. Eurozone inflation eased to 4.3% in September, but remains well above the 2% medium-term target, and while base effects should further ease the rate of increases in core prices December’s ECB projections may also have to factor in higher oil prices if tensions in the Middle East further unsettle markets.

“In October the discussion about policy will be very easy but I think that the discussions will focus on communication for December,” said one official from a central bank which will argue against further hikes following September’s increase in the deposit rate to 4.0%. “If inflation does not fall fast enough and geopolitical tensions affecting energy prices persist, we may see that in December some members see the case for a further increase.”

LEAVING PEPP ALONE

After a period of positive growth surprises, a rise in bond yields and weak export demand as China slows are weighing on the eurozone economy, the official said, noting that the debt market sell-off was also likely to sideline any suggestion of ending reinvestments under the ECB’s Pandemic Emergency Purchase Programme. The ECB would be wary of sparking speculation it might deploy its untested Transmission Protection Instrument in the event of any blowout in yields for countries such as Italy, the source said.

“If we remove the first line of defense and then have to use the TPI, the balance will be negative because we will have taken away the seal of an instrument that we have and an important part of its effectiveness lies in the mystery that surrounds it,” the official said.

A source at a different central bank also acknowledged the possibility of a push for a December hike, if inflation projections show the 2% target will be hard to achieve by late 2025.

“Then there might be a new proposal for or discussion of a further hike, but data availability may hold off any decision on that until early 2024,” the second official said.

“There is still some push from wages, which we think will in fact ease a bit. Many pay deals are done either late in the year or early in the new year – this is going to be a much more important factor than the ups and downs of the oil price, unless there really is a huge rise,” the official said.

So far the rise in bond yields has some positive implications for the ECB, as capital market financing costs move in line with benchmark rates and impose fiscal discipline on governments, sources said. (See MNI:Higher Yields Making EU Fiscal Rules Deal Harder-Officials)

“It’s okay at the moment, but it does need to be watched,” the second official said. “More importantly, it might rein in the 2024 budget plans of some capitals, which will help us.”

FIRST QUARTER SLOWDOWN

Several officials said the subject of cuts might emerge as early as the first quarter as the economy cools.

“I think the bar is now very high for a further hike and we would need some very large upside surprises in the data to hike again,” another source said. “I don't think cuts are on the agenda just yet, but there is obviously a real rate on interest we will be happier with that can certainly trigger the debate. I don't know if that rate is 0.5%, 1%, but it would certainly ease the case for cuts if we remain in restrictive territory.”

Some central banks though remain more nervous about inflation.

“If you think that you need rate cuts, or if you start talking about rate cuts, in the first quarter of next year, what would you have to see? There would need to be a [downside] surprise, because for 2025 inflation is still above target,” one source said. While October’s decision looks almost certain to be a hold, the path of inflation and wages will be key for December, the official added.

Next week’s deliberations could also see early discussion of the future of the ECB’s balance sheet, together with issues such as minimum reserve requirements and remuneration, though decisions are expected to await the conclusion of the ongoing operational framework review next year. (See MNI INTERVIEW: ECB To Move Cautiously On Reserve Remuneration)