ECB communications become messy as interest rate cuts continue

(Bloomberg) — So far, European Central Bank officials have largely succeeded in steering the euro zone economy toward 2% inflation with one vote. But as they close in on their target, opinions on what to do and when will vary.

The points of friction were already visible last week in Washington, where policymakers met to discuss the state of the global economy and the challenges that could arise.

Opinions – shared in speeches and conversations – differed not only about future interest rates. They also differed on how to communicate the ECB’s intentions, risks to the inflation outlook and quantitative tightening.

This makes the almost seven weeks until the December meeting of the Board of Directors a stage for potentially controversial debates. In the coming days, policymakers will receive inflation data for October and a first glimpse of the economy’s performance in the third quarter, which will likely confirm a recession in Germany.

While their response to these reports may provide additional insight into how they currently assess the health of the twenty eurozone countries, certainty about the outcome of their next decision will not be available for some time ahead of the November 5 US presidential election. creating a new element of unease.

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Financial markets are priced for about 35 basis points of easing in December, suggesting traders are almost equally torn between a regular quarter-point cut and a more aggressive half-point cut.

President Christine Lagarde was one of the first ECB officials to speak last week, preparing economists and investors for the broad outpouring of comments from her colleagues, who were in the US capital to attend the annual meetings of the International Monetary Fund . Of the 26 ECB officials, 19 gave their opinion.

Vice President Luis de Guindos and Board of Directors member Isabel Schnabel will add their voices to the mix in the coming days.

“You’re going to have people all week saying, oh, it should be 50, it should be 25,” Lagarde said in a Bloomberg TV interview. “No. Travel direction clear, pace to be determined on the basis of a backward and forward looking element based on the three criteria and the application of judgment.”

While most officials reiterated that these criteria – the inflation outlook, the strength of underlying price pressures and policy transmission – would inform their decision, some appear to have strong preferences.

Bundesbank President Joachim Nagel warned against rushing too quickly in cutting financing costs. His Austrian counterpart Robert Holzmann said in December that a quarter-point move is “likely,” and Lithuanian Gediminas Simkus argued that reading the data, “I see no case for a 50 basis point cut.”

At the other end of the hawkdove spectrum, Portuguese central bank chief Mario Centeno warned against limiting the ECB’s options to a move of just a quarter point.

“For an economy that has had an average inflation rate of 0.9% for ten years, for an economy that is not investing, for an economy that is supported by a labor market that is showing some signs of weakness, we must consider the possibility of increasing investments to do. steps,” he said.

Policymakers are aware that such an acceleration in the pace of easing would come at a cost, signaling a sense of concern on the part of the ECB about the economic outlook that may not be justified.

ECB chief economist Philip Lane assured concerned ears that disinflation in the 20-country eurozone is on track and the recovery is merely delayed.

Yet not everyone wholeheartedly shares his opinion. Some argued that a substantial undershoot of the 2% inflation target is already a real risk. Others expressed concern that the ECB’s tone is becoming too forgiving after Lagarde said at the latest press conference that there were more downside risks to prices than upside threats – while the mutually agreed monetary policy statement still avoided specifying a risk balance .

Belgian central bank chief Pierre Wunsch said he would “not overdramatize” the recent drop in inflation to 1.7% – the lowest level in more than three years.

“The risks to growth are clearly skewed to the downside. But it is not so clear that the inflation path is going in the same direction,” said the new head of the Spanish central bank, Jose Luis Escriva.

Such a disagreement will influence not only policymakers’ views on the interest rate path, but also the words they use to describe their intentions. At this point, the ECB says it will continue to take a restrictive position for as long as necessary.

These guidelines were already discussed at the last meeting and are likely to be closely assessed as early as December. With some arguing that policies should continue to suppress demand in the face of persistent inflation risks and others signaling a willingness to support the economy, the outcome depends heavily on the new December projections, which for the first time provide estimates for 2027 include. .

A so-called mechanical update to the September forecast at this month’s meeting suggested a sustainable return to the 2% inflation target no later than the second quarter of 2025.

The abandonment of the restrictive guidelines could be seen by the markets as a signal for faster cuts. Lagarde himself called the phrase a “kind of magical language” and said observers will be very attentive if and when it changes even marginally.

The debate also centers on where most officials see the neutral rate: an unobservable level that neither inhibits nor stimulates growth.

While some policymakers remain reluctant to discuss this publicly, others are becoming increasingly vocal. In Washington, Centeno said he sees this rate “at 2% or slightly below 2%,” while Olli Rehn cited research from the Bank of Finland that estimates the rate to be between 2.2% and 2.8%.

The discussion over the wording could also touch on the “meeting by meeting” approach, with some policymakers concerned that this could wrongly suggest that the ECB does not know where it is going, while others are still comfortable feel with this term.

Quantitative tightening could also become a source of contention for the Governing Council. The ECB has withdrawn most gradually maturing bonds from its policy portfolios and will halt all reinvestments this year.

If it sticks to these plans, the central bank could soon find itself in a situation where it eases financing conditions by cutting interest rates while simultaneously tightening them by removing liquidity from the markets.

Those who favor continuing QT in the background – also to create buying space for potential future crises – argue that the effect of shrinking bond holdings on the policy stance is minimal. Those who watch the bond market closely at points of stress emphasize that interest rate decisions should offset any tightening – no matter how large it may be.

To some extent, it was easier to agree on how to communicate if the ECB had clear guidelines for the future, or no guidelines at all. The next phase will be a shift to what Frenchman Francois Villeroy de Galhau described as soft signals – leaving more room for pushes and pulls in opposite directions.

“We are back to a ‘normal’ inflation regime, our response function should become more ‘forward looking’, with more confidence in the forecasts, and less dependent on monthly flash data,” he said in a speech in New York before the Flood. of comments in Washington.