MNI SOURCES: Energy Surge Pushes ECB Out Of 'Good Place'

The European Central Bank is set to retire its current “good place” language describing the state of monetary policy after its meeting next week, but while it must signal that risks to inflation have shifted to the upside due to the surge in energy prices, it will still need to make clear that any policy move is unlikely in the near term, Eurosystem sources told MNI.

Officials are acutely aware of the challenges of adjusting communication at a time when inflation risks stem largely from shifts in volatile prices for oil and natural gas which could fluctuate depending on developments in the Iran conflict or comments by U.S. President Donald Trump. But they agreed that the “good place” phrase deployed by ECB President Christine Lagarde in press conferences, and which has been repeated by national bank governors, is no longer appropriate.

“Hardening the language, and thus dropping the ‘good place’, is a given, in my view, but not too much hardening,” one official said, noting that the shift in market pricing towards around 40 basis points of rate hikes by the end of the year has already helped to tighten financial conditions and makes communication somewhat easier.

Another official stressed that the “good place” phrase was always meant to signal that the ECB was ready and able to react in either direction, and not to describe the economic situation itself. Now, the ECB must “very carefully back out of the ‘good place’ language without completely destroying the message,” he said.

While policymakers are wary of repeating what they now regard as their slow response to the inflation shock following the Russian invasion of Ukraine in 2022, particularly when the general population’s memory of the price surge remains fresh, most still urge caution for now. It will be essential to assess how the durability of any rise in energy prices and how widely it feeds through into inflation and growth, they said. (See MNI SOURCES: ECB's Ukraine Lesson Lowers Oil Shock Tolerance)

HAWKS

“Has the risk of the next move in rates being higher increased? Yep, but let’s be clear -- that's not the same as saying the next move in rates will be higher, just that it is a greater risk than two weeks ago. We think it has for now just taken the perhaps any small bias to downside risk off the table, but there is certainly no rush to see higher rates yet,” one said.

But, while no official expressed support for an immediate rate hike, several acknowledged that if energy-driven inflation pressures prove persistent, the next policy move could be upward.

“The issue is more about when the hike will take place than if,” another official said.

And hawkish members could push for a quicker reaction.

“The risks have changed and some members of the Governing Council will put pressure because our recent communication allows them to do so. Having insisted so much on the meeting-by-meeting approach, I think some will want to use it to raise rates quickly,” one official said.

“But we recommend a bit more calm,” he went on. “For March we will change the communication, stressing high volatility. The possibility that there may be changes makes it advisable that any adjustments are mainly reflected in the president’s press conference. I think the situation makes it advisable that anything written should be able to survive the passage of time.”

NOT 2022

Several officials noted that that the current shock appears smaller than that which hit the eurozone in 2022, a time when inflation risks were already tilted to the upside as economies reopened after Covid.

“Although there is no doubt vigilance is heightened and we look to avoid the post-Covid and early Ukraine mistakes, we must always remember the situation is different from 2022,” one official said.

“There aren’t already supply chain blockages. On energy, supply may be tighter, but it’s not almost completely cut off, so we haven't got quite the same derisking environment,” he said, adding “Governments haven't got the same fiscal space to throw in undoubtedly inflationary support measures for consumers and corporates.”

An ECB spokesperson declined to comment.