ECB: Another Fifty in September

Published on July 21, 2022
SGH Insight
Regarding September, markets seem confused by Lagarde’s comments today that essentially dropped the ECB’s guidance from its June Amsterdam meeting entirely, while expressing that today’s larger-than-communicated rate hike does not represent a change in the ECB’s probable rate hike destination, at least in this early, more visible part of the cycle.
The conclusion some seem to have taken from those comments, as implied by one reporter’s line of questioning, is that if the previous guidance was for a combined 75 bp of hikes between the July and September meetings (25 and 50), then ‘does 50bp today with an unchanged destination mean 25 in September’?
The answer, unmitigatedly, is no. As we wrote on July 13:
Our understanding is that there is strong and broad consensus across the Governing Council on the need to, at a minimum, get rates above the lower end of the ECB’s roughly 1-2% estimate for nominal neutral rates for the euro zone — in an expeditious fashion.
And importantly for markets:
…for all the market concerns over recession and the specter of a severe energy squeeze from Russia over the winter, having come late to the hiking cycle, and with some ground to be made up before rates are “normalized,” the default mode for the ECB in the early part of the cycle will be towards 50 bp hikes
While shying away from a discussion of where exactly “neutral” might lie, Lagarde today did indeed emphasize that the ECB’s goal to “progressively” raise interest rates until it gets to a broadly neutral position has not changed. Furthermore, the TPI is not just about opening the 50bp option for today, but its mere existence in the background will allow the ECB to “walk the journey.”
Beyond the clear economic rationale to start the process of “frontloading” rates now – an important term that Lagarde also used repeatedly today — this linkage between the roll-out of TPI and the decision to hike by 50bp was explicitly laid out in both the formal communique and multiple times in President Lagarde’s press conference.
So, while we believe the Governing Council has gotten out of the business of providing explicit guidance for its next meetings, at least for now, we think that is simply to acknowledge that the old 25+50 consensus has been tossed out, and to avoid putting the Council in an awkward situation again in the future if it needs to “surprise” from expectations.
We do not see that in any way lessening the odds of 50 in September.
Market Validation
Bloomberg 7/25/22

The European Central Bank may not be done
with big increases in interest rates after surprising with an
initial half-point hike last week, according to Governing
Council member Martins Kazaks.
“I would not say that this was the only front-loading,”
Kazaks, one of the ECB’s most-hawkish officials, said in an
interview in Frankfurt. “I would say that the rate increase in
September also needs to be quite significant.”

Bloomberg 7/25/22

The European Central Bank will follow a
step-by-step approach in raising borrowing costs, according to
Governing Council member Ignazio Visco.
“We will see depending on data how to go on, but this does
not mean that we are not going to proceed in a gradual way,” the
Italian central bank governor said in an interview with
Bloomberg Television. Gradualism “means moving step by step, not
being very slow.”
He added that “there is no way now to say now” whether the
ECB’s next step should be a quarter-point or half-point
increase.

Bloomberg 7/25/22

European Central Bank President Christine Lagarde said interest rates will be increased as much as is required to bring inflation back to 2%.
“We are sending a clear message to companies, employees and investors: inflation will return to our target value of 2% in the medium term,” she said in an op-ed for Germany’s Funke Mediengruppe. Measures taken so far “are already having an impact on interest rates across the euro area.”
The comments come a day after the ECB raised rates more than expected, ending eight years of negative interest rates to fight inflation that hit 8.6% in June and is expected to accelerate further. The 50 basis-point hike brought the deposit rate to 0%, ending eight years of negative rates. Investors see about 113 basis points of addition ECB rate increases by year-end, according to market bets.
“We will raise interest rates for as long as it takes to bring inflation back to our target,” Lagarde added. The Governing Council will “decide on the right pace for our next steps based on the newly available data.”

The Governing Council of the European Central Bank decided to hike interest rates today by fifty basis points as it simultaneously rolled out a Transmission Protection Instrument (TPI) to address unwarranted fragmentation risks in European bond markets – should such intervention prove necessary.

That 50 bp hike came despite explicit guidance from ECB President Christine Lagarde to expect a more modest 25 bp hike for lift-off from the ECB’s long standing negative 0.50% deposit rate, a consensus that was echoed by many of her fellow GC members.

We were, however, very pleased by the Council’s unanimous decision to break from that guidance with a more aggressive hike today; clearly the appropriate decision on a policy basis, and directly tied to today’s rollout of the TPI.

We were also pleased as we were among the only major ECB watchers to call a “surprise” 50bp hike almost a week ahead of reports on Tuesday in the press that opened the door to the possibility of a 50 and helped re-shape last-minute market expectations (see SGH 7/13/22, “ECB: The Growing Odds of Fifty”).

With that out of the way, and on a substantive note, we point you to our July 13 report because we believe what we wrote last week remains highly relevant for the ECB’s next meeting in September, and beyond.

Regarding September, markets seem confused by Lagarde’s comments today that essentially dropped the ECB’s guidance from its June Amsterdam meeting entirely, while expressing that today’s larger-than-communicated rate hike does not represent a change in the ECB’s probable rate hike destination, at least in this early, more visible part of the cycle.

The conclusion some seem to have taken from those comments, as implied by one reporter’s line of questioning, is that if the previous guidance was for a combined 75 bp of hikes between the July and September meetings (25 and 50), then ‘does 50bp today with an unchanged destination mean 25 in September’?

The answer, unmitigatedly, is no. As we wrote on July 13:

Our understanding is that there is strong and broad consensus across the Governing Council on the need to, at a minimum, get rates above the lower end of the ECB’s roughly 1-2% estimate for nominal neutral rates for the euro zone — in an expeditious fashion. 

And importantly for markets:

…for all the market concerns over recession and the specter of a severe energy squeeze from Russia over the winter, having come late to the hiking cycle, and with some ground to be made up before rates are “normalized,” the default mode for the ECB in the early part of the cycle will be towards 50 bp hikes

While shying away from a discussion of where exactly “neutral” might lie, Lagarde today did indeed emphasize that the ECB’s goal to “progressively” raise interest rates until it gets to a broadly neutral position has not changed. Furthermore, the TPI is not just about opening the 50bp option for today, but its mere existence in the background will allow the ECB to “walk the journey.”

Beyond the clear economic rationale to start the process of “frontloading” rates now – an important term that Lagarde also used repeatedly today — this linkage between the roll-out of TPI and the decision to hike by 50bp was explicitly laid out in both the formal communique and multiple times in President Lagarde’s press conference.

So, while we believe the Governing Council has gotten out of the business of providing explicit guidance for its next meetings, at least for now, we think that is simply to acknowledge that the old 25+50 consensus has been tossed out, and to avoid putting the Council in an awkward situation again in the future if it needs to “surprise” from expectations.

We do not see that in any way lessening the odds of 50 in September.

Looking beyond September, Lagarde also pushed back on the more dire recessionary growth predictions, even while acknowledging significant downside risks to growth.

Whether or not those risks pan out as feared, here, too, markets and analysts appear to keep reverting (or perhaps wanting to revert) to a pre-Covid reaction function that assumes an activist response from the ECB to downside growth risks. That was reflected very neatly by a question from one reporter today about rate cuts — on literally the first day that the ECB has hiked rates in about a decade.

That is legacy thinking, we believe, and it is inconsistent with the severe inflationary risks of “unleashed forces” that Lagarde pointedly referenced in Sintra, and the risk-reward perceived by the ECB of being too loose to stem inflation in this post-Covid world versus being too tight on growth.

In today’s presser, one thing you did not hear from Lagarde was an attempt, as in the past, to belabor distinctions between headline and core inflation, external from internal drivers, energy from base, but rather her focus was on inflation’s persistence, breadth, pass-through, and the pipeline pressures that remain.

Anything can happen, but the whole point of front loading is to get the obvious and “easy” early rate hikes under the belt, quickly. That will put the ECB in a better position to calibrate and adjust its pace of rate hikes and ultimate destination should the expected winter growth crunch pan out even worse than expected – if, that is, inflation allows.

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