By Balazs Koranyi
FRANKFURT – A flurry of rate hikes by the U.S. Federal Reserve will complicate life for the European Central Bank over the coming year, even if their policymakers appear unconcerned for now to be going their separate ways.
The Fed on Wednesday signalled a quick sequence of rate hikes to bring down inflation, accelerating its divergence from an ECB that continues to pledge copious stimulus this year and essentially rule out any hike until 2023.
Fundamentals back the ECB’s stance. European inflation is lower, wage pressures are still muted and employment has yet to recover to pre-pandemic levels, all suggesting that high inflation, a function of soaring energy prices, will indeed pass, as now predicted.
The problem lies with the increased aggressiveness of the Fed’s stance because “nimble” action, as outlined by Chair Jerome Powell, suggests the U.S. central bank is also going complete its tightening cycle quicker than in the past, leaving the ECB with a shorter time to act.
“If the Fed finishes hiking in 2023, then history suggests they’ll be thinking about cutting by 2024,” Danske Bank Chief Strategist Piet Haines Christiansen said.
“That leaves the ECB a very narrow window to act because I just can’t see the ECB tightening while the Fed is on hold or preparing for an easing cycle.”
While independent, the ECB has tended to follow the Fed with a small lag and the handful of rate hikes it has made out of sync with its U.S. counterpart, including moves in 2008 and 2011 moves, are now widely viewed as policy mistakes.
Even under a hawkish scenario, the ECB’s first hike would not come before the spring of 2023, which would leave it time for around two increases before the Fed finishes, analysts say.
PAUSES AND ESCAPE CLAUSES
The ECB could move faster but, having missed its inflation target for a decade and carrying a legacy of misguided rate hikes, the ECB seems almost certain to err on the side of caution, particularly with a dovish majority on its rate-setting Governing Council.
Indeed, analysts only see timid moves with pauses and escape clauses, suggesting that the ECB will not only act with a big lag, its moves will also be more modest.
This represents such a big disconnect with the Fed that markets appear reluctant to place much faith in the ECB’s rates outlook.
Despite an explicit statement by ECB chief Christine Lagarde that any move this year is “very unlikely”, investors have priced in 20 basis points of hikes before 2023.
That leaves the bank with a tricky communications challenge for its Feb 3 policy meeting.
To protect its credibility, Lagarde cannot even entertain the idea of a hike this year, but pushing back too hard would force her to tie her hands even more, a risky exercise given a stubbornly volatile and uncertain inflation environment.
“Through 2022, despite all the pressure they’ll face from high inflation to politics, they’ll keep on stressing the sequencing of their moves and by extension that pushes back the hike to next year,” Pictet Wealth Management strategist Frederik Ducrozet said.
The ECB’s guidance now stipulates that rates will only go up “shortly after” the end of bond purchases that are currently set to run at least into the fourth quarter and in any case for as long as necessary.
“The problem is 2023, as markets will price in the end of bond buys by then, even when big supply will be coming from the likes of Italy,” Ducrozet said. “It’s just difficult to see ECB normalisation without bond market volatility.”
That could in turn make the ECB hesitant, fearful that soaring debt costs could derail growth.
If the ECB fails to seize the opportunity to normalise policy, rates will remain deep in negative territory, leaving it with little room for easing during the next downturn and adding weight to the criticism that ultra-easy policy has become the norm, not the exception.
(Editing by John Stonestreet)