Dissonance Over Rate Trajectory Prompts ECB Gathering

As the European Central Bank sets interest rates on Thursday, attention will be focused on the increasingly acrimonious path ahead.

‍

Investors have become accustomed to getting an early glimpse into what borrowing costs may look like in the coming weeks, if not months, despite the Federal Reserve's insistence on taking decisions "meeting by meeting.".

‍

With officials disagreeing over what amount of guidance is sufficient and which indicator of inflation will be of the most significant importance, it is going to be harder than ever to deliver a clear message in the midst of the most forceful bout of monetary tightening in the history of the euro.

‍

With the collapse of the US bank SVB, there has been an additional element of uncertainty and investors have lowered their bets on how high-interest rates will rise in the future.

‍

As of now, European officials do not see any contagion risks as a consequence of this situation. Bruno Le Maire, French Finance Minister, said on Monday that the case in the US is "unique," and he highlighted the lender's ties to the tech sector, which is much smaller in Europe than it is in the US.

‍

There are however money markets that have priced a lower peak in the ECB's deposit rate of below 3.75% for the first time in almost a month for the ECB's deposit rate. Furthermore, they are a little less certain about the planned half-point hike this week, even though that move is still widely expected after the poor reading for underlying inflation in the eurozone in February.

‍

Even before the SVB erupted into a major crisis, tensions among rival factions within the 26-member Governing Council over the future course of action had already spilled out into the open. Italian central bank chief Ignazio Visco has slammed colleagues advocating "prolonged" rate rises after Austria's Robert Holzmann urged four more significant changes last week.

‍

As a result of such public sparrings, it is uncertain whether ECB policymakers will be able to present a "unified picture" of their monetary policy roadmap, warns Joerg Angele, an economist from Bantleon in Zurich.

‍

“Whilst the doves continue to call for a cautious approach to interest-rate raising with reference to the core inflation rate, the hawks continue to advocate new hikes in interest rates,” he said.

‍

There is no guarantee that new estimates of the gross domestic product and inflation through 2025, which are also due on Thursday, will settle the debate.

‍

Trade Algo polled over 200 analysts who believe that forecasts for headline price increases will be lower than last quarter's outlook due to a plunge in energy prices. There is a possibility that the path for core inflation is going to be revised higher in the near future - at least initially.  

‍

This risks intensifying a debate that was already taking place at the time of the February gathering, according to an account of that meeting. The officials discussed the weight to be placed on the underlying measure with one argument being that "there is a possibility that some elements of core inflation may move quite quickly.".

‍

Analysts' opinions concerning how far the ECB must tighten its monetary policy are influenced by this uncertainty.

‍

Trade Algo's poll this month, which was based on a global survey of economists, predicted that the deposit rate would peak at 3.75% - up from the current level of 2.5% - and would move in three quarter-point steps afterward.

‍

“As we know what is going to happen this week, we are all looking for signals on what is going to happen in May," said Karsten Junius, chief economist at Bank J Safra Sarasin. “In spite of this, the Governing Council should not be tempted to tell us what is going to happen in the next two months because it is a long time. By that time, we will have two more readings on inflation."

‍

An increase in the output of the European Union could slow the moderation of those figures. It has been particularly good in the job market over the past few years, so labor unions have been calling for wage increases of double digits to compensate for lost purchasing power.

‍

The ECB must give a clear message that takes the inflation problem seriously by giving such signals - along with worrying data on the underlying prices - according to Ulrike Kastens, an economist at asset manager DWS.

‍

The Federal Reserve may still find it difficult to convey its stance without causing unwanted gyrations in financial markets, particularly as the SVB's fall has reshaped expectations for the Fed's monetary tightening process in the wake of its fall. As a result of a barrage of comments from officials in the last few weeks, investors have been quick to reevaluate their wagers.

‍

It would be especially difficult for the ECB's hawks if they do not have some sort of commitment that they will vote to raise interest rates by half a point at the next meeting, according to Jussi Hiljanen, head of SEB's European macro and fixed income research department.

‍

“The task of signaling 50 basis points for May will be a massive challenge, especially if the press release is not as explicit as it could be," he said. Trying to strike the right balance in such a situation would prove to be a daunting task for Lagarde in such a case.