ECB grapples with endgame for hikes a year after liftoff

A YEAR after the European Central Bank (ECB) began lifting interest rates, officials are thrashing out the final stages of what’s already their toughest-ever campaign of hiking.

Policy makers gathering this week in Frankfurt are poised to unveil another quarter-point increase in the deposit rate, to 3.75%, on top of the 400 basis points of monetary tightening enacted since last July.

They’re less likely, though, to offer guidance on the following meeting, in September, when some are angling for one last move while others prefer a pause. Despite some hawkish Governing Council members sounding more conciliatory of late, that debate remains in full swing. Investors and economists lean toward a 4% peak in rates.

“The key challenge will be to make clear that the Governing Council will bring inflation toward target but that nevertheless the end of the hiking cycle is nearing,” said Martin Wolburg, senior economist at Generali Investments Europe. “The message will be that rates stay at their peak levels for longer.”

It’s already proving tricky to convince the market of that intention, with analysts surveyed by Bloomberg predicting cuts in borrowing costs as early as next spring. Past assertions that proved inaccurate may fuel such doubt, like ECB President Christine Lagarde’s late-2021 description of rate hikes the following year as “very unlikely.”

As well as trying to rebuild credibility, the ECB and other big central banks have spent much of the past year and a half striving to engineer a soft landing for their economies after Russia’s war in Ukraine super-charged inflation and upended the post-pandemic rebound.

The rapid salvo of hikes — which only tend to hit home with a lag of a year or more — means their still-unfolding impact is as important to ECB decision making as the slew of economic reports arriving by September.

A year on from liftoff, inflation has sunk to 5.5% from almost double that at its peak — but that’s due more to a reversal in natural gas prices than the ECB’s action so far. Once energy and food are removed, so-called core inflation remains higher than 12 months ago. Projections only see overall price gains near the 2% goal in 2025.

The economy, meanwhile, has so far dodged a recession even as higher energy bills and borrowing costs squeeze households. A surprisingly strong labor market is underpinning consumption. But some sectors — particularly manufacturing — are struggling. Output in Germany, the bloc’s biggest member, shrank over the winter.

That backdrop leaves ECB officials at odds over the finale to their hikes.

Yannis Stournaras, who heads Greece’s central bank, has cautioned that growth may be underperforming, suggesting inflation could be weaker as a result. Italy’s Ignazio Visco, similarly, has said price pressures may abate faster than expected. Both are likely to favor a September pause.

At the other end of the spectrum, Bundesbank President Joachim Nagel has argued that it’s too early to proclaim “a certain kind of a victory” over inflation, hinting that another hike may be needed in the fall.

Muddying the waters, Mr. Nagel’s traditionally hawkish counterpart in the Netherlands, Klaas Knot, told Bloomberg TV last week that any action beyond July “would at most be a possibility but by no means a certainty.”

“The Governing Council is becoming more divided on how much further tightening the euro-area economy needs,” said Nerijus Maciulis, chief economist at Swedbank. “Although it’s likely to keep the doors ajar for further hikes, it will refrain from repeating that the job is ‘not done.'”

The upshot is that policy makers, rather than telegraphing future moves as they have in recent months, will adhere more closely to their longstanding mantra of data dependency — much like the Federal Reserve is doing.

Both central banks could face the choice of a pause or another increase in September. The Fed, though, has hiked more and began earlier — in March 2022 — with officials in Frankfurt still being accused of responding too late to the spike in prices.

In December 2021, as the Bank of England became the first major central bank to lift rates and euro-area inflation stood at 5%, ECB policy makers clung to arguments that elevated readings would be transitory.

And while the ECB can’t yet declare “mission accomplished,” Chief Economist Philip Lane is confident that the efforts of the past 12 months will get it over the line. — Bloomberg