MNI SOURCES: Markets Overplaying ECB's Hawkish Shift

The European Central Bank’s hawkish shift following its last Governing Council meeting is more limited than markets’ reaction would suggest, particularly given the weekend’s trade deal, Eurosystem national central bank sources told MNI, admitting that while there is a new mood music it has been overinterpreted.

President Christine Lagarde emphasised the ECB’s meeting-by-meeting approach as it held the deposit rate at 2% on Thursday, after which markets pared back expectations for cuts this year by roughly six basis points, though sources told MNI there is still a strong possibility of a further 25-basis-point cut, even if most Governing Council members would now need to see a deterioration in the outlook for this to occur.

Financial markets and the economy have coped better with global trade uncertainty than feared, they said, while the weekend’s EU-U.S. trade deal, which saddles European exporters with a baseline tariff of 15% but reduces the chances of significant retaliation any time soon by Brussels, was in line with baseline assumptions at the ECB meeting, officials said. (See MNI INTERVIEW: ECB Should Not Cut Rates Again- OeNB's Holzmann)

“Overall, the risk is still for another cut this year given the June projections, but we have time over the summer to assess data and truly be meeting-by-meeting, data dependent without second guessing scenarios,” one national central bank official said, adding that the trade situation looked to be as expected, assuming the EU-U.S. deal is ratified following the negative response to the agreement from some member states.

“It will weigh on output, but much will depend on corporate ability to take a price hit,” the official said.

EASING ASSESSMENT

Policymakers’ assessment of the likelihood of further easing is somewhat lower now than in June, officials conceded. 

“I think it remains a risk [another cut] rather than a done deal. There are certainly plenty who would not object to another cut, but the mood music now seems to suggest that the June cut was an insurance cut,” another source said.

“As for timing for a possible [rate cut], I would just say some time this year, but the deeper we go, perhaps the less likely,” he added. 

September is the most likely point for a cut, officials said, with Q2 key for any additional rate cut. One raised October as a possibility.

“The debate between hawks and doves is shaping in terms of the tolerance for deviations from the 2% target,” an official said, “Doves came across as willing to fine tune policy to prevent any downside deviation from the target and hawks as putting the bar higher for acting.”

On Thursday, markets reacted more strongly to Lagarde’s comments in the press conference than to the statement, noted another source.

“My sense is that markets still want to think that somehow we are trying to do forward guidance by stealth. It is not the case. We are fully discretionary, ready to respond,” the official said. 

STATEMENT KEY

 "The statement matters more,” said another official, pointing in particular to the phrase that rate decisions “will be based on its assessment of the inflation outlook and the risks surrounding it.”

Lagarde went too far in saying that the ECB had “essentially closed” the “disinflationary cycle,” another official said, adding “I truly believe that this language was a mistake.”

Her reference to the ECB’s being “in a good place,” does not mean so much that it is happy to continue to pause as that it has room to respond to any shocks -- in either direction -- which might materialise, some officials said.

The weekend’s trade deal would tend not to add to upside price risks given current EU trade patterns, another official said, with tariff costs shared between U.S. consumers and European business margins, but there could be downside pressures as other exporters attempt to diversify away from the U.S. This leaves a good argument for a September cut to keep in line with projections, given the absence of fresh upward price pressure and the removal of some uncertainty, but overall the official’s national bank leans towards continuing to hold until price developments point more clearly to the next move. (See MNI INTERVIEW: Trade Retaliation To Make Job Harder For ECB)

“It is incredibly dull to say so, but we really are data dependent and will decide meeting by meeting,” the source said.

An ECB spokesperson declined to comment.