MNI SOURCES: Market Pricing For Cut Prompts ECB Jawboning

European Central Bank policymakers are keen to ensure markets do not price in rate cuts prematurely, and will continue to stress lingering upside risks to inflation in coming weeks even as policy looks set to remain unchanged in December and possibly for some months afterwards, Eurosystem sources told MNI.

Comments in recent days by President Christine Lagarde and several national central bank chiefs came after markets priced in a deposit rate cut by as early as April despite ECB assurances that rates would remain sufficiently restrictive for as long as necessary to ensure inflation’s timely return to target. If market pricing becomes too loose too early, it could ease credit conditions and fuel inflation, potentially pushing back cuts or even making another hike necessary, one source noted. (See MNI ECB WATCH: ECB Holds Rates As Inflation, Growth Slow)

Despite assurances by various officials that further hikes in this cycle remain possible, none who spoke to MNI considered that an increase above 4% was feasible on Dec 14, though key data before the meeting includes November flash inflation. December’s statement, too, is likely to remain little changed, while the month’s fresh macroeconomic projections should point to both continuing inflationary pressures and a weak outlook for growth, one official said.

“It is basically the same message as the last meeting, but with the forecast and new projection it will take on a new meaning,” the official said.

DILEMMA FOR CENTRAL BANKS

With inflation coming down but still at high levels even as economies slow, monetary policy makers in several major countries face a difficult task to manage market expectations which themselves have implications for inflationary outcomes as they insist on the message that rates will stay high for longer, the official noted.

“I think this a good summary of the current dilemma for central banks have. We cannot say that we have reached the peak because the announcement itself could end up moving the peak,” he said, adding “We see the inflation risks to be very balanced, with a slight downward bias due to lower growth.”

Pricing for a first cut moved out to mid-year following the comments by Lagarde and her colleagues, though it has since come back to indicating a lower deposit rate by April.

Several sources said discussions over of a change to rates were likely to begin in earnest in the first half of next year and by as early as the spring. While pointing to faltering growth, they stressed that the ECB will remain data-dependent and a cut will hinge on clear signs inflation is returning to target, and noted that Middle Eastern instability increases the risk of an upside shock for oil prices in particular.

“I think they mean it in the way of ‘Come on, let's stop speculating when we are going to cut rates. At the moment it's off the table, because we are still not there,” said one official, speaking after the initial retreat by markets rate pricing. The last part of the inflation battle might prove the most challenging, the official noted. “It certainly could happen that they have to raise rates even further just to get to 2%."

An ECB sentiment gauge in August showing that consumer inflation expectations for the next 12 months jumped to 4% from 3.5% also caught the eye of some policymakers, another source said, though he added that some officials downplayed the importance of such surveys and that actual inflation data had since surprised to the downside. (See MNI INTERVIEW: ECB Should Hold Until At Least Spring-Vujcic)

WORLD MORE INFLATIONARY

Markets still have to internalise the reality of a new more persistently inflationary environment, in which green transformation provides a long-term impulse to prices and a slowing China no longer exerts a deflationary drag on the world, another source said.

“The idea is to return inflation to target - which is around 2% - we are not going back to what we had in 2010 to 2021. People are not used to that,” the source said. “I think this is an important psychological point in this debate.”

The issue of how long to continue reinvesting the proceeds of maturing Pandemic Emergency Purchase Programme bonds will also continue to exercise the ECB’s Governing Council as it moves towards policy normalization. Ending reinvestments early – or at least a tweak to the current guidance – could be discussed in December, but no decisions are likely ahead of publication of the operational framework review, due sometime around spring 2024.

An ECB spokesperson declined to comment.