The ECB would rather see a recession than allow inflation to get out of control, officials say.
The European Central Bank will consider slowing its pace of hiking to 50 basis points at its December meeting, but while more dovish Governing Council members are increasingly worried about an economic slowdown, hawks are confident they have the numbers to sustain tightening well into the new year, eurosystem sources told MNI.
While 50 basis points was seen by most officials as December’s most likely choice, some said doves might even offer to back a third consecutive 75-basis-point hike on Dec 15, if in return the ECB waits until it has reached its rate cycle peak before beginning to run down its balance sheet via quantitative tightening. With end-of-year eurosystem inflation projections expected to show little sign of a let-up, the Council is likely to favour further increases of 50 or 25 basis points for the following two meetings at least.
“Doing 75 in December doesn't exclude doing more than 25 in February and March,” one official said, expressing scepticism that anyone could yet identify the high point for rates. “We could go beyond that.”
MEETING COMES AFTER FED
December’s meeting will come a day after that of the Federal Reserve, widely expected to reduce its rate of hikes to 50 basis points. But while this will be key to setting the tone for markets, the ECB started hiking later and from a lower level than the Fed.
Another source stressed that the ECB would comply with its inflation mandate despite the risk of recession, and added that officials were surprised by markets’ dovish interpretation to October’s policy statement.
Crucial for the December decision will be the recommendation before the meeting by chief economist Philip Lane, but Governing Council members would rather overshoot once or twice than allow expectations spiral out of control, a second official said. Hikes might continue past March, though possibly at a relatively low pace such as 25 basis points if the ECB begin to runs down its stock of bonds and is seeking to calibrate its effect on markets, the source said. (See MNI INTERVIEW: ECB To Hike More Than Expected, Rattle Markets)
The approach to QT will be another subject for debate in December, with the most likely outcome being to reduce reinvestments under the ECB’s Asset Purchase Programme to about 75% or 80% of the total debt coming due, officials said. QT would be unlikely to start before the end of the first quarter or early in the second, one said.
Still, some national central banks are becoming more concerned about downside risks to the eurozone economy, a sentiment also expressed in a recent speech by Executive Board member Fabio Panetta, who warned publicly of the dangers of going too far, too soon.
DOVES MORE VOCAL
The doves are no longer willing to be “cornered” by Governing Council hawks, said another official, who was confident that the most probable outcome of the December meeting was a 50-basis-point increase, taking the deposit rate to 2%.
While sticking to the ECB’s core task of reaching 2% inflation in a timely manner might be right in principle, the result could be a “very damaged economic fabric, in a coma that can be difficult to revive,” the official said.
“Fifty is right,” another official said. “Get to 2% then go flexible and gradual. Everyone sees this turn is coming, even the hawks. We need instead to establish a proper narrative of where we are going.”
Some doves are likely to seek a pause in hikes after December, though they have little prospect of success, one more hawkish source said, adding that 50 basis points was the minimum increase needed to end the year and that at least another 100 points between now and the end of March was likely.
While a 2.5% deposit rate would be around the lower reaches of restrictive levels above neutral, hawks are determined to preserve the ECB’s inflation-fighting credentials. (See MNI SOURCES: More ECB Policymakers See Restrictive Rates)
“What is at stake is the credibility of the ECB,” one source said.
An ECB spokesperson declined to comment.