ECB seen shunning half-point hike for smaller moves from July

Price growth is seen hitting the 2% goal in 2024 — a precondition for rate hikes under ECB guidance — though the 1.2%-3% forecast range is wide.

Efforts by European Central Bank hawks to secure an initial half-point hike in interest rates will fail as policy makers agree on a series of smaller increases, according to a Bloomberg survey of economists.

The ECB will lift the deposit rate — now at -0.5% — by a quarter-point in July and again in September, the poll showed. While in line with President Christine Lagarde’s vow to end subzero borrowing costs in the third quarter, that’s less aggressive than the path sought by officials like Austria’s Robert Holzmann.

Calls for more forceful action as the ECB winds down years of stimulus measures follow another euro-area inflation record last month, when prices jumped 8.1% — more than four times the target.

Lagarde, however, is expected to use her June 9 news conference to affirm the more cautious exit strategy she outlined last week — namely an imminent end to large-scale asset purchases before rate liftoff next month.

“The ECB will all but pre-commit to a deposit-rate hike in July, reiterating its intention to end quantitative easing as planned at the end of the second quarter,” said Claus Vistesen, chief euro-zone economist at Pantheon Macroeconomics Ltd. “The question is whether it will be 25 or 50 basis points. We think the former, but the pressure is rising to act more decisively.”

Derivatives markets think the answer will be 50, shifting on Thursday to price in a move of that size.

Key to the ECB’s decision will be fresh projections drawn up with all 19 euro-area member states. Significant upward revisions to inflation for this year and next are expected, along with a much weaker outlook for economic expansion due to Russia’s war in Ukraine and supply-chain bottlenecks in Asia.

Price growth is seen hitting the 2% goal in 2024 — a precondition for rate hikes under ECB guidance — though the 1.2%-3% forecast range is wide. The ECB itself has struggled to accurately predict inflation, underestimating it since energy and food costs began to soar last year.

“Many Governing Council members have lost faith in the ECB’s ability to forecast inflation in the current environment and have seen enough signs of upside inflation pressures to warrant action,” said Jan von Gerich, chief analyst at Nordea. The only reason they won’t raise rates in June is an old commitment that QE will have to be officially terminated first, he said.

Survey respondents envisage quarterly hikes in the deposit rate from December to September next year, taking it to 1%. The main refinancing rate is seen reaching 1.5% at end-2023 — the level a majority of economists deem as neutral, neither restricting nor spurring economic growth.

That scenario is unlikely to please doves including Executive Board member Fabio Panetta who’ve warned against raising rates this far, instead urging a gradual approach and maybe even a pause at zero.

“The inflation environment will require a faster normalization process,” said Ulrike Kastens, an economist at DWS Group who expects “no hints toward monetary tightening — yet.”

Officials have stressed that financial conditions will remain accommodative, even when rates start to rise, and haven’t discussed shrinking the stack of bonds bought under the ECB’s regular and pandemic programs.

But its balance sheet could already start contracting this year. Economists see banks repaying about 670 billion euros ($718 billion) of loans as crisis-era terms expire.

That, along with the conclusion of net asset purchases, has some worried that bond yields in vulnerable euro-region members could spike. The spread between Italian and German 10-year debt has widened by 42 basis points since the ECB’s last meeting. For Spain, it’s up 20 basis points.

What Bloomberg Economics Says…

“The ECB has limited capacity to address a blow-out in spreads in an environment of high inflation — policy normalization in the euro area comes with risks that other central banks don’t face.”

— David Powell and Jamie Rush. Read the full note here

Most respondents said the ECB’s plan to flexibly reinvest the proceeds of maturing bonds from its pandemic program won’t be sufficient to contain market turbulence. They see a stronger vow to act if needed as the most likely remedy, alongside a new tool, likely announced by end-September.

© 2022 Bloomberg

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