MNI SOURCES: Even ECB Hawks Confident Inflation On Track

MNI (SINTRA, PORTUGAL) - Even customary hawks at the European Central Bank are gaining confidence that gradual easing will still see inflation on a track back to the 2% target, calculating that two or three 25-basis-point interest rate cuts can be made before there is any question that monetary policy will turn accommodative, Eurosystem sources told MNI.

“Incoming data is good and it’s a matter of not being complacent and to keep seeing those numbers that are on the projections,” one source told MNI. “We know it’s going to be bumpy, but so far so good, and the next projections will be important.”

Another official from a different national central bank with a similar profile agreed, saying that cutting the deposit rate at quarterly meetings, which coincide with updates of the ECB’s macroeconomic projections, seems the appropriate path for now.

“It’s a less bad scenario for inflation,” he said. “Cutting quarterly makes sense to me at the moment.”

There is a broad consensus that the ECB will reduce the Deposit Rate by a further 25 basis points to 3.5% after its first 25bp cut of the cycle in June, officials said, although accepting that decisions will be taken on a meeting-by-meeting basis and be data dependent.

“September is a likely possibility and will happen barring surprises,” another usually hawkish official said, adding that the ECB did “a great job” in anchoring inflation expectations, and dismissing fears that the experience of the recent inflation surge might make it more likely that expectations could come adrift again in future.(See MNI SOURCES: September Rate Cut In Sight For ECB)

Rates will remain at restrictive levels until the end of this year, though this may come into question early next year, the official said.

BACK ON TRACK

A more centrist source said he was gaining confidence that inflation was back on track, something which he argued was unsurprising given the long years of low inflation which preceded the supply chain disruptions of Covid and the energy shock. The ECB remains on track for cuts in both September and December, he said, adding that he expected the Deposit Rate to reach its cycle low somewhere between 2% and 2.5%.

Another Eurosystem source pointed to a speech by the ECB’s Chief Economist Philip Lane in which he anticipated a gradual removal of restriction over coming quarters.

“We are still in restrictive territory and we'll remain there this year,” he said. “If I had to make a guess right now, I'd say under current conditions, the shift from restrictive will happen around 3%.”

While officials are shy of putting a figure on the real neutral rate of interest, estimates of r-star vary between 0% and 0.5% - compared to perhaps -0.5% to 0% before Covid. An ECB paper published earlier in the year said the median model estimate had risen by about 30 basis points compared to mid-2019, breaking a long period of decline.

“We are more focussed on lending stats, consumer behaviour etcetera, to gauge whether the policy setting remains restrictive or not,” said another source.

GEOPOLITICAL RISK

But, while the sense that r-star remains distant provides confidence, Eurosystem sources remain alert to geopolitical risk. French election results caused a tremor in markets, but the U.S. elections in November loom larger.

“If Trump arrives and starts imposing tariffs, bullying Nato and so on, it will have an impact on inflation,” said another senior source, from a central bank generally considered to be dovish.

Officials also increasingly cite a downturn in growth as a risk, though one of the hawks played this down.

“I think consumption will pick up in the second half. Anyway, the growth forecast is modest so small downward changes do not change much,” the source said.

An ECB spokesperson declined to comment.