MNI SOURCES: Cheaper Oil Gives ECB Room Before Next Hike

Steeper-than-expected falls in oil prices together with June’s encouraging flash readings for both headline and core inflation are boosting the chances the European Central Bank will be able to avoid rushing into another rate increase, Eurosystem sources told MNI, though several officials wanted more proof inflationary pressures are contained.

While another 25-basis-point increase in September is still seen as the likelier outcome, an increasing number of policymakers are becoming receptive to the idea of a hold that month, and of taking additional time before pulling the trigger on what will still very probably be a single additional tightening move following June’s. 

While oil prices have come down, some inflationary effect is inevitable, sources said.

"We must be cognizant of the damage already done. There is already pass-through and that has the possibility of becoming more embedded," one source said, adding that the likeliest scenario is still a September hike. Another official agreed, despite acknowledging that the speed of the retreat in energy prices has taken the ECB by surprise.

"A September hike remains the most likely outcome given where we are, but things could change. Perhaps energy will flow quicker than thought and we won't need to hike, and headline inflation dipping back towards 2% could reinforce some thinking like that," a third official said, echoing a growing camp of policymakers who could support a pause in September if incoming data, including new projections, so permit.

The perceived fragility of the U.S.-Iran Memorandum of Understanding is adding to the uncertainty. While energy prices could continue to fall on the back of rising supply from established and new producers, they are equally capable of snapping back sharply if hostilities resume in the Strait of Hormuz, officials said, noting that this dynamic underlines the wisdom of the Governing Council's meeting-by-meeting, data-dependent stance. (See MNI SOURCES: ECB September Meeting 'Live' Despite Iran Deal )

PROGRESS IN CORE INFLATION

Governing Council members have largely maintained a unified front since the Gulf crisis began, but persistent geopolitical uncertainty, and the fact that while there has been some inflation pass-through, June’s readings were lower than expected, are beginning to expose fault lines over the timing of any further tightening. Macroeconomic forecasts are heavily dependent on unpredictable variables, while moves in oil futures markets can prove ephemeral, sources said.

“For September, I will be very attentive on how core inflation evolves. It is important for deciding to move or not,” one official said. “Because the mood that can be around, and how it is reflected in futures is one thing. Another thing is the data that we will be receiving. I need to see progress in core inflation to justify skipping.”

Others argue that a clear improvement in the ECB’s macroeconomic projections would give policymakers more time to wait until October or December to confirm or rule out the second hike, even if this is still very likely.

"I think whether we raise rates in September or not will basically depend on the forecast. If we indeed see that inflation is returning to the target more quickly and in a sustainable way, it can wait," one source said.

Some officials noted that there could be tactical advantages in deferring action to October or even to December, when a fresh set of ECB projections would provide cleaner analytical grounds for a decision. "For me, there may be advantages to holding in September to give us more time," said one policymaker, who nonetheless kept a second hike firmly on the table. "The inflation and labour market data will help us make the decision."

Others, though, cautioned that waiting to see whether inflation becomes embedded could risk acting too late, while a hike in September could be followed quite quickly by a cut if necessary.  Any increase could "easily be reversed in H2 if need be and it would not be a policy mistake," one source said, arguing that some signal from the Council of its determination to contain inflation is warranted regardless, while a durable end to the Gulf conflict could prompt enough of a recovery in euro area sentiment to render further tightening unnecessary.

An ECB spokesperson declined to comment.