The European Central Bank will almost certainly implement the eighth successive increase in its official deposit rate on Thursday, this time by 25 basis points to 3.5 percent. The interesting bit will be whether it signals it might be ready to at least start thinking about thinking about a pause. Given a welcome downturn in inflation recently and signs that the euro-zone economy is flatlining at best, a hint that rate hikes are no longer automatic at every meeting would be prudent.
The US central bank has successfully convinced the US Treasury market that it will skip just one meeting, and will be back raising rates next month. It wants to erase expectations for rate cuts this year which had crept increasingly into US money-market prices, and preserve flexibility. The ECB is paddling furiously in a similar boat, but it can ease back on the stroke rate if the Fed starts coasting. Perhaps it might want to join in the “skipping” game too by indicating it will only take rate decisions at quarterly economic reviews, which form part of this week’s agenda with the next one due in September.
The Australian and Canadian central banks had tried to preempt the Fed earlier this year by pausing. Unfortunately, they had to capitulate as still-too-sticky core inflation left them exposed. Both were forced into raising rates again by 25 basis points last week as the gap to Fed levels increased by too much for comfort.
It's clearly less than optimal that the euro zone slipped into recession over the winter, after two consecutive quarters of negative growth. So it wouldn’t be a huge surprise if growth expectations for this year are trimmed at this meeting’s economic update. A nudge upward in forecasts for core inflation, excluding food and energy, is also on the cards. Despite a dip to 5.3 percent in May's core measure from a peak of 5.7 percent in March, services prices and wage pressures remain elevated. This week's expected hike is needed to continue to subdue inflation; how much additional insurance policymakers will feel is required is now the bigger question.
The ECB governing council ought to be increasingly conscious that due to monetary policy time lags, its year-long rate-hiking cycle has yet to be fully felt in the euro economy. Furthermore, not only has it paused its massive quantitative-easing bond purchases, but it has moved into passive tightening mode by no longer reinvesting around half of the maturing debt. If bond yields get stressed again, there is far less firepower to hand.
The ECB is too traumatised from letting runaway inflation slip away from it last year to suddenly pronounce an end to its current trajectory. But a Fed resolutely on hold would make it much easier for the ECB to sit the rest of the summer out at 3.5 percent. It won't want to make any commitments on that until its July 27 meeting — but it shouldn’t rule out the option to do so either. Conveniently, its next meeting is also the day following the Fed’s. Where the Fed leads, other central banks follow.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Views are personal and do not represent the stand of this publication.
Credit: Bloomberg
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