Euroland: ECB Watch - Softly Inching Closer to a Rate Hike
Joachim Fels and Elga Bartsch (London)
The message from the Introductory Statement at today’s ECB press conference was virtually unchanged from last month’s statement: the ECB Council continues to think that “the medium-term outlook remains in line with price stability”, but there is “a case for continued vigilance with regard to the materialisation of upside risks to price stability.” In the Q&A session, however, ECB President Trichet made a subtle change compared to last month when he repeated “we have no bias and we are vigilant” but omitted the key phrase “we keep all our options open”, which had been part of his mantra in the last couple of months. That this was an intended change became clear when Trichet declined to repeat the “all options open” phrase even when asked specifically about it in a follow-up question. To us, this and the fact that the ECB President only mentioned upside risks to price stability indicates that the Council has internally waved goodbye to the idea of another rate cut and is very gradually paving the way for a first rate hike later this year. Provided that inflation expectations remain at elevated levels and the recovery remains on track, we think the ECB could signal a bias at the next press conference on 2 September and then hike rates by 25 bp on 7 October, in line with our long-standing view of a first tightening in 4Q.
Regarding the economic analysis, the Council remains “confident that the recovery of economic activity will continue” and states that “the conditions for a broadening and strengthening of the recovery are in place”. The statement notes strong growth outside the euro area, which supports export growth, and repeats the expectation of a pick-up in business investment and a recovery of consumer spending in line with disposable income growth. Both upside and downside risks to the growth outlook are mentioned: on the upside, possibly stronger near-term growth momentum following a stronger-than-expected 1Q and “ongoing robust growth in the global economy”; on the downside, high oil prices and continuing global imbalances.
By contrast, in the section of price developments, the statement only mentions upside risks to the ECB’s main scenario of price stability over the medium term, but no downside risks. Same as last month, the upside risks listed are (1) the possibility of further upward pressure on oil and commodity prices, (2) the possibility of further one-off tax increases and administered price hikes which would translate into second round effects on wages and prices, and (3) “relatively high” inflation expectations derived from financial market indicators, which despite their limitations call for “particular vigilance”. In the Q & A, President Trichet added that the Council expects headline inflation to remain at or above 2% well into the first half of next year. Against this backdrop, the statement includes an appeal to the “social partners” for wage moderation.
The passage on the monetary analysis states that despite the recent moderation of annual M3 growth, there remains substantially more liquidity in the euro area than is needed to finance non-inflationary growth and repeats the well-worn assessment that “the stock of excess liquidity, if it persists, may pose an upside risk to price stability over the medium term.”
All in all, we view today’s subtle changes, notably the omission of the “all options open” phrase, as a sign that the ECB Council is, softly but surely, inching closer to a rate hike in 4Q, in line with our expectations. However, if inflation expectations ease considerably during the summer, or if the recovery falters, rates could be on hold for longer. If not, Jean-Claude Trichet looks likely to drop the “no bias” phrase at the next press conference on 2 September, in our view, which would signal a first rate hike in October. |
