The central bank for the 20-country euro zone has already lifted rates by a record 350 basis points since July in the hope of stopping runaway price growth.
The European Central Bank will raise interest rates for the seventh meeting in a row on Thursday as its long fight against stubborn inflation continues, with only the size of the move still open to debate. The central bank for the 20-country euro zone has already lifted rates by a record 350 basis points since July in the hope of stopping runaway price growth. But getting inflation down to its 2% target is still years away, leaving policymakers with little choice but to tighten policy again this month and beyond.
A 25 basis point move, slowing the pace after three straight 50 basis point hikes, appears the most likely outcome, although a bigger increase is still a possibility at what is almost certainly not the end of a historic tightening cycle. The clincher could be a compromise among policymakers on what signals to send about future increases.
Conservative “hawks”, who hold a comfortable majority in the Governing Council, are leaning towards a bigger increase. But they have signalled they could live with a smaller move as long as the ECB indicates that May is not the end of its hikes, even if some peers – notably the U.S. Federal Reserve – are on the verge of reaching their own interest rate peaks.
Another issue will be just how big a majority ECB President Christine Lagarde wants backing the decision. Many hawks could live with a smaller move given the right guidance but their dovish colleagues are likely to voice loud dissent if the hike is bigger, leaving the ECB once more speaking with many voices, seen as a weakness for years.
Part of the compromise could be a deal to end reinvestments from July of maturing debt bought under the ECB’s 3.2 trillion euro Asset Purchase Programme – a modest step that would shrink further the bank’s bloated balance sheet, even if the inflation impact would be small.Markets see a 75% to 80% chance of a 25 basis point move while the vast majority of economists polled by Reuters were also betting on the smaller hike. Rates are then seen peaking at around 3.75% in September.Supporting a possible ECB downshift, the U.S. Federal Reserve lifted rates by 25 basis points on Wednesday and signalled it may pause further increases.
ALL ABOUT INFLATION
Economic fundamentals provide plenty of fodder for both sides of the argument, even if the dovish arguments seem to multiplying. Supporting the case for a smaller move, the euro zone economy barely grew last quarter and lending figures showed the biggest drop in credit demand in over a decade, suggesting past rate hikes are starting to work their way through the economy.
If squeezed hard, this credit downturn could morph into a full-blown credit crunch, weighing on growth which is barely in positive territory to begin with. At 3%, the ECB’s deposit rate is already restricting economic activity, and underlying inflation has also stopped rising – at least for the time being.
“From a risk management perspective, shifting to 25 bps would give the ECB the flexibility to deal with both upside and downside risks to growth and inflation,” Davide Oneglia, at TS Lombard, said. “So, a 25 bps hike is not necessarily ‘dovish’. For now, we maintain our call for a 3.75% ECB terminal rate. “Hawks argue that underlying price growth remains far too high and suggests that inflation could level off above the ECB’s target unless the bank acts more aggressively. They say these risks are exacerbated by a tight labour market, especially since wage growth has been quicker than predicted and the jobless rate has fallen to an all-time-low despite the near-recessionary environment.
“We still expect the ECB to deliver a 50 bp hike this week,” Bank of America said. “This should come with an emphasis on data-dependence, an indication that there is still ground to cover, and a clear signal, again, on the need for a sustained move lower in core inflation for them to pause in the hiking cycle. “The ECB will announce its policy decision at 1215 GMT and Lagarde will hold a press conference at 1245 GMT.
Source:financialexpress.com