CB keeps markets guessing on rates, warns of ‘layer cake of shocks’
With less than two weeks until the next European Central Bank meeting, the bloc’s policymakers appear uncertain about the future of interest rates.
According to LSEG data, financial markets are currently pricing steady at the April 29-30 meeting, followed by an increase in June. The majority of investors expect the ECB’s key interest rate to reach at least 2.5% by the end of the year; This is an increase of 50 basis points or more from current levels.
Speaking to CNBC at the IMF Spring Meeting in Washington DC on Wednesday, German Bundesbank President Joachim Nagel said that volatility in oil prices leaves the ECB “between our baseline and our downside scenario.”
“The whole situation is very opaque, very murky, and we need to decide in two weeks what will happen next,” he said, adding that “data is coming in daily in the form of news.”
Questions about reopening the Strait of Hormuz are at the center of uncertainty, Nagel said, calling the critical waterway the “heel of the world economic system.”
“If there is more uncertainty to come, it will also affect the decision we need to make when we meet in two weeks,” he said. “[A] The meeting-to-meeting approach is the right way to do it, and we’ve been doing it in the past. “This becomes even more important in this very complex day.”
Nagel hinted that policymakers are still considering the path of interest rates.
“It’s really important to wait until we have all the information available for the day we need to make a decision,” he said. “And this meeting-to-meeting approach is the best way to conduct or conduct monetary policy.”
Nagel said inflation was expected to remain around the central bank’s 2% target, but also warned that continued uncertainty could force the ECB to react if prices rise more than expected.
Pointing once again to the Strait of Hormuz as the key to decision-making, he said, “We must include options in the method we do; monetary policy should not exclude anything.”
“We have to be cautious here… In terms of monetary policy, this is still something we have to look at what happens in the next two weeks. We could see a lot of new things coming in two weeks, so I’m really cautious about giving an accurate indication of what the next step is that we need to do on the monetary policy side.”
‘Layer cake’ of shocks
Latvian central banker Martins Kazaks, who sits on the European Central Bank Governing Council, also told CNBC that policymakers are taking a meeting-by-meeting approach. When asked whether April was too early to raise interest rates, he replied, “We’ll see.”
“For example, what are we seeing in terms of the intensity of repricing? How is it spreading to other parts of the economy?” He said and noted that core inflation for the euro area did not rise slightly in March.
Kazakhs told CNBC that economic shocks in 2020 and 2022 — when the Covid-19 crisis and Russia’s large-scale invasion of Ukraine shook the global economy — made central bankers more cautious, and no one knows exactly how the war will end.
“Nobody knows if other shocks will follow, and the problem we’re seeing in 2020 and 2022 is that when the shocks come… it’s like a layer cake,” he said. “Shocks layer on top of each other, they interact. They can trigger some nonlinearities. And I think it’s very important for central bankers to be careful and cautious and see what happens to these nonlinearities. If they come into play, and I sometimes call them second-round effects, then we need to act.”
He added that Europe was currently in a “comfortable situation” but Kazakhs said authorities should monitor data pressures as the situation unfolds.
“For the euro area, markets expect two increases starting from June,” he said. “I have nothing against it at the moment. Let’s see how it develops. But of course at some point we will have to achieve it. These non-linearities are definitely the element that we have to look at very carefully and, if necessary, act very quickly.”
ECB President Christine Lagarde at the end of March He said the central bank was ready to raise interest rates even if the expected rise in inflation turned out to be temporary.
If the shock, even if not very permanent, causes our goal to be exceeded [inflation] Speaking to the audience at the “ECB and Observers” conference held in Frankfurt, Germany, Lagarde said, “A measured policy adjustment according to the target can be guaranteed.”
“Leaving such an overshoot completely unaddressed may pose a communication risk: the public may find it difficult to understand an unresponsive reaction function.”
ECB in ‘crisis mode’
Carsten Brzeski, ING’s head of global macro research, said in an email to CNBC on Thursday that “the ECB’s ‘good place’ is no longer there.”
“Instead, the ECB has reverted to crisis mode and reverted to a ‘riding on view’ approach, shifting its focus from long-term forecasts to actual developments,” he said.
According to Brzeski, key variables to watch include actual inflation data, survey-based long-term inflation expectations and wage developments; Brzeski said policymakers will consider these against slowing economic activity and financial stability concerns.
ING believes that the ECB expects a first wave of inflation, starting with gasoline prices and continuing with knock-on effects on transport costs, food prices and industrial products.
“As long as this remains a single and limited wave, there is no need for the ECB to raise interest rates,” Brzeski said.
“The longer the blockade in the Strait of Hormuz lasts, the higher the chance of hitting some trouble spots. That’s why we see the ECB announcing at least one insurance rate increase. Some might go so far as to call this a policy mistake.”
Antonio Alvarenga, professor of strategy and entrepreneurship at the Nova School of Business and Economics, said ECB officials were being more cautious and conditional than ever in providing guidance.
“The ECB enters its April decision with an unusually broad and contradictory range of plausible scenarios, in the context of weak growth in key economies, sticky inflation dynamics and renewed upside risks to energy prices from Middle East tensions,” he said in an email Thursday. “Being too specific in this environment can be costly because facts can change quickly before the meeting.”
Alvarenga added that “traditional forward guidance on a possible path has effectively diminished” as central bank policymakers turn to “response function” communication that preserves the maximum option for the next move.
“[The war] It changes what kind of guidance is reliable. The best they can do is communicate contingencies: ‘here’s the interest path,’ rather than ‘we’ll react if inflation expectations are unanchored or energy-based second-round effects occur,'” he told CNBC.
“The tradeoff for this approach is greater volatility in the market and a wider spread in expectations. But from the ECB’s perspective, the greater risk is being squeezed into a pre-announced trajectory and then having to abruptly reverse it if the shock develops.”
