New increases in the cost of money for the European Central Bank. Without delay. The new increase in interest rates will arrive at the mid-December meeting. In the pot there are another 75 basis points, for the third increase in a row of this carat. Christine Lagarde, speaking in the usual hearing in the European Parliament, traced the map of Frankfurt’s next moves. That is, fourth hike in a row and announcement of the tightening of the Eurotower balance sheet, the so-called Quantitative tightening (Qt). The fight against inflation remains the priority. Even more than the recession that will be. We need to bring rates “into restrictive territory” is the mantra.
Words are important. The timing as well. And although Lagarde has said several times that he wants to abandon the use of forward guidance tools, therefore prospective indications for financial market operators, he provided significant insights during his hearing before members of the Parliament’s Committee on Economic and Monetary Affairs EU. First, the process of raising interest rates is not over.
“We expect to raise rates further to the levels needed to ensure inflation returns to our medium-term target in a timely manner,” he explained. This is because acting on the cost of money remains “the main tool for fighting the rise in prices”. However, it is complicated to make predictions, as Lagarde articulated.
Decisions will be taken “meeting by meeting”, from meeting to meeting, and will be “data dependent”, i.e. dependent on economic data. And here we have to wait for next Wednesday, when the flash estimate on the general consumer price index for the countries of the Eurozone will be published. It will be double-digit, says the consensus of analysts, but it will depend on how much. And, above all, what will be the value of Core inflation, i.e. purged of the energy component. We will see. The important thing, explained Lagarde, is to be aware of where you want to go.
“We know we need to get rates high enough to bring inflation back to the 2% target, and that could mean taking them into restrictive territory. But we will decide it from meeting to meeting, and on the basis of the data», said the number one of the ECB. The uncertainty comes from an ever-changing picture.
“I’d like to think that inflation reached its peak in October, but I’m afraid it’s not correct to do so,” stressed Lagarde, calling into question above all the increases in the energy sector.
Second indication, the Qt. In other words, the shrinking of the budget, which has gone from around 2,000 billion euros following the collapse of Lehman Brothers to the current over 8,800 billion. Too much, in the face of high uncertainty and extreme turbulence in multiple sectors. The Qt will be passive, therefore it will not provide for the reinvestment of maturing securities. And it will concern the Asset purchase program (App), i.e. the “regular” purchase program and not the Pandemic emergency purchase program (Pepp) launched in spring 2020. In December “we will illustrate the key principles to reduce the bond holdings in our portfolio of the asset purchase programme. The balance sheet should normalize over time in a measured and predictable way,” Lagarde noted. According to economists at S&P Global Ratings in the latest report, “Economic Outlook Eurozone Q1 2023: Reality Check” , the ECB’s budget “could fall by around 3 trillion euros in three years. All eyes are on the end of the first quarter of 2023 for the new course to become fully operational.
The third signal is on price dynamics. And on this front, the problem is understanding when the peak will be. For now, Lagarde has admitted it bluntly, he hasn’t touched yet. Maybe it’s after the Christmas holidays. But these are empirical estimates, as Morgan Stanley points out. Both Black Friday and Cyber Monday are also commercial practices in Europe, and energy inflation is spreading across all production chains. And therefore on consumers. “It is possible that the peak will be between February and March next year”, warn the economists of the Dutch ING.
The greatest unknown, for Christine Lagarde, is the internal disagreements on the Board of the ECB. An increasing number of governors are expressing a willingness to be more aggressive against the flare-up in prices. Germany, the Netherlands, Austria, Belgium, Slovenia, Slovakia, plus the Baltics, are all too clear on the way forward. That is to say, increases by three quarters of a point for December as well. At the count, it is easy to assume that the balance will tip towards a more orthodox approach. Even Spain, the historical exponent of the gradual withdrawal of monetary stimuli, is changing its mind. “What we have done so far is not enough to achieve the goal,” said the governor of the Banco de España, Pablo Hernández de Cos. A change of course which, a few days before the decisive meeting of the Eurotower, could be decisive for understanding the direction of the next increase.