European Central Bank’s battle lines shift with Lagarde urged to speed up tightening

THE European Central Bank (ECB) might be slower than its peers to embrace the idea of hiking interest rates, but its public debate over how aggressively to act is suddenly shifting very fast indeed.

Just three weeks ago, policy makers had only just started to coalesce around a first move in July. Now they are openly discussing a half-point increase, whether to end sub-zero borrowing costs as soon as this year and then where to go next.

While that discussion reflects heightened alarm at rapid inflation, it also shows how the changing policy cycle has energized ECB officials whose stance for much of the past decade has featured repeated salvos of stimulus.

The momentum with which the discussion has shifted raises the prospect of more heated dialog before a pivotal meeting on June 9 that should seal the end of ECB bond buying and formally prime investors for a July rate move.

With that comes the possibility that more policy makers might publicly call for open aggression on inflation at a time when most global counterparts have long taken action. They include the US Federal Reserve, which delivered a half-point increase earlier this month, and Sweden’s Riksbank, which abruptly changed course to hike in April.

“The debate is whether inflation in Europe is due to energy-price increases or if there’s more to it,” said Pietro Reichlin, a professor of economics at Luiss University in Rome. “The US situation is clearer, there we see inflation. But in Europe we may be going in that direction, so concern is legitimate.”

Tensions among officials may be already materializing, with ECB President Christine Lagarde’s blog post on Monday signaling a timetable of two quarter-point increases in July and September irking more hawkish officials who craved at least the option for a bigger hike, according to people familiar with the matter.

Three policy makers have now publicly aired a half-point move. Dutch central bank governor Klaas Knot set the ball rolling on May 17, favoring a quarter-point hike unless the inflation outlook worsens.

Latvia’s Martins Kazaks told Bloomberg this week that half-point increases could be discussed, while Austria’s Robert Holzmann insisted in another interview that such a move is already “appropriate.”

“It would keep people on their toes and signal to markets that we’ve understood the need to act,” he said. “Everything else risks being seen as soft.”

Carsten Brzeski, an economist at ING in Frankfurt, observed that with eight weeks to go before the prospective rate hike on July 21, a lot can still change.

“We’re getting inflation data for two more months until then,” he said. “If core inflation accelerates further in a significant way, 50 basis points are possible.”

Against the backdrop of pressure building for bold action, other policy makers have publicly insisted that the ECB’s mantra of “gradualism” should prevail.

“A 50-basis-point hike is not part of the consensus at this point, I am clear,” Bank of France Governor Francois Villeroy de Galhau told Bloomberg Television in Davos, Switzerland on Tuesday. His Italian colleague, Ignazio Visco, mused last week that July was “perhaps” the moment to hike, stressing that “we can move gradually.”

Speaking on Wednesday, Olli Rehn of Finland, who backs a 25 basis-point hike in July, also stressed gradualism.

Meanwhile, Executive Board member Fabio Panetta said ending negative rates is justified, though he also stressed that policy normalization needs to be gradual and that pre-committing to further steps would be “unnecessary and unwise” because of a “clear weakening of soft leading indicators” and signs of economic stress. 

Ms. Lagarde herself also told Bloomberg TV that the inflation shock hitting the euro region isn’t demand-driven, giving the ECB some breathing room.

“It’s definitely an inflation that is fueled by the supply side of the economy,” she said from the World Economic Forum in Davos. “In that situation, we have to move in the right direction, obviously, but we don’t have to rush and we don’t have to panic.”

Yet the momentum of the argument briefly appeared even to have swayed Ms. Lagarde. She also said “positive territory” by the end of the third quarter was an option — a prospect that, on the face of it, suggests more than 50 basis points of tightening by September.

“When you’re out of negative, you can be at zero, you can be slightly above zero,” Ms. Lagarde said in her interview with Francine Lacqua. “This is something we will determine on the basis of our projections, on the basis of our forward guidance.”

Whatever the case, the debate among ECB officials has now clearly moved on from whether to act and when to do so first, to already wondering aloud where rates are likely to end up. That’s far beyond the horizon of the April 14 meeting discussion, at least as the president described it at the time.

On Monday, Ms. Lagarde described “a progressive further normalization of interest rates toward the neutral rate,” and on Tuesday, Villeroy de Galhau happily went so far as to share a timetable on what that could mean — and in what time frame.

He repeated a prior estimate of the neutral rate — the level at which monetary policy neither constricts nor stimulates — at between 1% and 2%.

“We should probably go to this neutral rate till next year — the pace will depend on actual inflation and activity data,” he said. “Then we will see — is it sufficient to bring inflation back to 2%, as I mentioned, in 2024? Or should we go beyond the neutral rate?” — Bloomberg