The ECB interest-rate rise leads to questions about the first cut

It is not even 24 hours since the European Central Bank interest-rate decision and quite a bit has changed. Let us start with the announcement.

In order to reinforce progress towards our target, the Governing Council today decided to raise the three key ECB interest rates by 25 basis points.

25 basis points sounds like so much more than 0.25% doesn’t it? But my main initial point is that we were right to take note of the Reuters “sauces”.

staff macroeconomic projections for the euro area see average inflation at 5.6 per cent in 2023, 3.2 per cent in 2024 and 2.1 per cent in 2025.

So there was a simple logical progression from inflation being more than 1% over target to the increase in the Deposit Rate to 4%. Although there was a curiosity because really they should be looking at 2025 now and they did this with that.

a downward revision for 2025.

On which basis they did not need to raise interest-rates. But I seemed alone in making that point.

There was a further significant element to this and it has been reinforced this morning by the head of the Estonian central bank Madis Muller.

At yesterday’s European Central Bank Council meeting, we decided to raise interest rates by another 0.25%, but we also made it clear that, to the best of our knowledge, no further interest rate hikes are expected in the coming months. Interest rates have already reached high enough to be expected to bring inflation back to close to 2% in the euro area over the next two years, slowing credit growth and cooling the euro area’s economic momentum.

So that’s all for now folks as they say in the cartoons. Or maybe not.

This, of course, does not rule out the possibility that if the rapid price increase behaves more persistently than expected, interest rates will still have to be increased in the future.

So back to Definitely Maybe. Of course markets saw right through the latter part and pushed the Euro lower ( to 1.0650 versus the US Dollar) and the stock market higher in response. At the time the Euro Stoxx 50 rose by 40 points and this morning it is up by nearly 90 points. Partly that was due to the anticipated end to the rises in interest-rates but I am sure this was also in play.

My question is If the data dependency and held for long are at odds with each other, and if this can be contradictory and if you are prepared to cut rates if growth slows further. In other words, if it is sufficiently restrictive, could that sentence imply a cut?

This was a really awkward question for President Lagarde who wanted to give the impression of being a doughty inflation fighter. So much so she could not even bring herself to say the word cut.

This [rate cut] is not even a word that we have pronounced.

Problems are mounting for President Lagarde

The problem essentially is when that inconvenient issue called reality intervenes. We have just looked at one issue which comes from this.

We will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, our interest rate decisions will be based on….

That leads to the tactical issue of being asked what happens if the data suggests a cut in interest-rates? A perfectly valid question which feeds into my next problem for President Lagarde.

 Our past interest rate increases continue to be transmitted forcefully.

If so why did she need another one? Especially in the light of the next part of her statement.

 Financing conditions have tightened further and are increasingly dampening demand, which is an important factor in bringing inflation back to target.

Indeed even the ECB is being forced to admit that the Euro area economy is struggling.

The economy is likely to remain subdued in the coming months. It broadly stagnated over the first half of the year, and recent indicators suggest it has also been weak in the third quarter.

That is very different to what President Lagarde told us as recently as February.

Overall, the economy has proved more resilient than expected and should recover over the coming quarters.

Those who follow my work will know that use of the word “resilient” by central bankers is an awful sign and so it has proven again. But we are back to the question about interest-rate cuts if things continue to get worse, and that has been highlighted again by this morning’s wages numbers.

In the euro area, wages & salaries per hour worked increased by 4.6%, while the non-wage component rose by 4.0% in the second quarter of 2023, compared with the same quarter of the previous year.

So wage growth was already slowing from the peak of 5.3% at the end of 2022. So real wages continue to fall and if the wage growth slowing continues may fall even faster which is more bad news for consumption prospects.

Also the idea of the woman who dismissed the rising inflation data as a “hump” now doing this is very close to parody.

So we looked very closely at all those data. And to give you an example, we spent hours and hours yesterday, morning and afternoon, with the usual presentation by staff in the morning and by the Chief Economist and the member of the Executive Board responsible for markets to have as much intelligence, numbers and analysis as possible.

Next up is the rather obvious dissent going on.

The European Central Bank’s interest-rate hike sparked a backlash from Italy and Portugal, while Spain’s deputy premier signaled her expectation that tightening is now over. ( Bloomberg)

Whilst Italy might have been expected to dissent, Portugal has been a well-behaved Euro area member even quietly taking its medicine in the Euro area crisis. Indeed since then it has been considered a success. Also there has been an attempt to buy Italy off with lots of EU next generation money. In terms of the specifics it makes me wonder what the Martians might have done to deserve this?

“The ECB, which doesn’t care about the economic difficulties of families and businesses, is increasing the cost of money,” Italian Deputy Prime Minister and League Leader Matteo Salvini said on broadcaster Rete 4 on Thursday evening, according to Ansa. “Lagarde is living on Mars.” ( Bloomberg)

Still I suppose it would open up a new export market for Hermes and sun beds.

Comment

This is always one of the more awkward stages in monetary policy. Let me illustrate with this from CNBC this morning.

Rising energy prices could ‘change the story’ for the ECB: Morgan Stanley.

Yesterday saw the price of the West Texas Intermediate benchmark for crude oil rise above US $90 per barrel reinforcing that point. But there are always going too be some signs of inflation at this point and even before the latest rise interest-rates were 4.25% higher in response.So you have to make your move then hold your nerve.

Also it seems impossible to move away from the mistakes of Christine Lagarde or rather what is in this instance a bare faced lie.

On the transmission channel, there is evidence that the current hiking cycle is transmitting to financing conditions faster than previous ones.

The last hiking cycle resulted in Greece, Ireland, Spain and Portugal requiring bailouts due to changes in financing conditions.

So for the impact of yesterday’s move I think we are back again to Newt from the film Aliens.

It won’t make any difference

At least to inflation, but it may well affect the economy adversely.