Despite the conflict in Ukraine, European Central Bank President Christine Lagarde stated in March that the Governing Council plans to continue on the path of monetary normalisation. We anticipate her reiterating that position in the news conference following the ECB meeting today. While she’s unlikely to give much clarification on the precise date of the first interest rate hike, she’ll almost certainly continue to tacitly support financial market forecasts for a move in the second half of this year.
The ECB’s hawkish stance does not appear to have been influenced by the war in Ukraine, and it presently has the upper hand. Both headline and core inflation are at all-time highs, and poll results indicate that the euro-area economy has yet to be significantly impacted by rising commodity prices. We continue to believe that the region’s GDP growth will be stifled by rising energy costs and a drop in business and consumer confidence. Although the risks are skewed toward an earlier trek, we believe the first hike will occur in December.
Back in February, despite Russia’s invasion of Ukraine on February 24, Lagarde maintained her hawkish tone in March, tacitly endorsing a rate rise this year by no longer ruling it out. Lagarde promised to be a consensus builder when she took over as president from Mario Draghi, and she has kept her word by listening to the hawks.
Executive Board Member Isabel Schnabel and Bundesbank President Joachim Nagel have been consistent members of the hawkish gospel choir since the previous meeting. They both agree that the Governing Council must continue on its monetary policy normalisation course.
Of course, that viewpoint isn’t shared by everyone. Ignazio Visco, Governor of the Bank of Italy, said on March 17 that the prognosis had deteriorated significantly since the ECB’s estimates were adopted at last month’s meeting, and that they were now obsolete. However, despite scant indication of a tight labour market encouraging stronger wage rise, the doves’ wings have been cut by inflation, which has soared to about 8%.
Given the possibility for monetary tightening to put additional upward pressure on Italian bond rates, Visco is bound to be more dovish. Some of those fears may be alleviated by a new crisis tool that the ECB is allegedly developing.
The hawks have gained support from economic statistics released since the ECB’s last meeting. Not only is headline inflation roughly four times the ECB’s objective, but core inflation is also one whole percentage point higher. It’s doubtful that we’ll see a big slowdown until 3Q.
Furthermore, the PMI survey indicates that the euro-area economy fared better than predicted in March. It also hinted to a price increase that had never been seen before.
However, we expect the conflict to have a considerable negative impact on the euro-area economy, as rising energy costs reduce family spending power and uncertainty slows investment. In the coming quarters, we expect GDP to expand by roughly 0.3 percent. As the economy continues to recover from the epidemic, this means a recession is unlikely, but the spring and summer will seem like one.
With the exception of no longer ruling it out for this year, Lagarde has offered little insight on the schedule of the first raise. The ECB’s forward guidance simply states that it will happen “some time” after the monetary authorities halt net bond purchases. Additional net acquisitions are planned to end in June.
Members of the Governing Council have also been adamant about the sequence. In a speech in Paris on March 31, Chief Economist Philip Lane reaffirmed that the ECB will carefully stick to it, referencing the Federal Reserve and the Bank of England’s playbooks. In a speech on March 21, Nagel reaffirmed his devotion to that sequence.