The Fed is sticking to its roadmap

Federal Reserve meeting minutes suggest rate hikes are not higher than expected. But what is the ECB doing?

The minutes presented on Wednesday evening US Federal Reserve on the latest Monetary Policy Committee meeting did not inspire investors to expect the Fed to adopt a tougher than expected stance to combat high inflation. On the contrary, stockbrokers saw indications that the central bank might take a slightly less strict course following an initial phase of larger rate hikes towards the end of the year.

Another topic on the stock exchange is the massacre at an elementary school in the state of Texas. US President Joe Biden called for consequences from the recurring rampages with firearms. Arms manufacturer stocks rose sharply. It’s a known reaction. After massacres, many US citizens fear stricter laws and quickly stock up on weapons and ammunition. So the corporations benefit from such atrocities. Smith & Wesson and Vista Outdoor were both up 6.8 percent on the day of the massacre. Sturm, Ruger & Co. increased in price by 4.1 percent.

But back to interest rate decisions. While the roadmap in the US seems pretty clear until the end of the year, the debate within the European Central Bank (ECB) really picks up speed.

Just three weeks ago, monetary policymakers had only just begun to agree on a first step in July. Now they are openly discussing an increase of half a percentage point, whether borrowing costs should be reduced to zero before the end of this year and what to do next.

The dynamism with which this discussion is progressing means that a lively debate is expected ahead of the decisive session on June 9th. The end of the ECB’s bond purchases is to be sealed there and market participants are to be prepared for an interest rate hike in July.

This means that there is a possibility that more central bankers will publicly call for a more aggressive fight once morest inflation given that other countries have already taken measures.

The ECB is struggling to find a clear line

“The debate is whether inflation in Europe is due to the rise in energy prices or whether there is more to it,” said Pietro Reichlin, an economics professor at the Luiss University in Rome. “The situation in the US is clearer, we see inflation there. But in Europe we might be moving in that direction, so the concern is legitimate.”

Tensions between council members are already becoming apparent. ECB President’s blog post Christine Lagarde on Monday announcing a schedule of two quarter-point hikes in July and September angered hawks in the council, who wanted at least the option of a larger hike.

In the meantime, three central bankers have publicly spoken out in favor of an increase of half a percentage point. Dutch Governor Klaas Knot got the ball rolling on May 17 by endorsing a quarter-point hike only if the inflation outlook does not deteriorate.

Latvian central bank governor Martins Kazaks said Bloombergthat a half-point hike might be discussed, while Austria’s central bank governor Robert Holzmann even insisted such a move was “appropriate” in July.

“It would keep people alert and signal to the markets that we saw the need to act,” he said. “Anything else would run the risk of being perceived as weak.”

Carsten Brzeski, an economist at ING in Frankfurt, noted that eight weeks before the expected rate hike on July 21, much can change. “By then, we’ll get inflation data for two more months,” Brzeski said. “If core inflation continues to accelerate significantly, 50 basis points is possible.”

Amid mounting pressure for bold action, other monetary policymakers have insisted that the ECB’s mantra of “gradualism” must prevail. “A 50 basis point hike is not part of the consensus right now,” Banque de France governor Francois Villeroy de Galhau told Bloomberg TV in Davos. His Italian counterpart Ignazio Visco suggested that July was “maybe” the right time to hike rates.

Lagarde himself told Bloomberg TV that the inflation shock in the eurozone was not demand-driven, giving the ECB leeway. “It’s definitely supply-side fueled inflation,” she said in Davos. “In this situation we obviously have to move in the right direction, but we must not rush into anything and not panic.” (apa/bloomberg)

At a glance

The US Federal Reserve will probably not take any sharper interest rate moves. This emerges from the minutes of the most recent meeting published on Wednesday. Observers even believe that small interest rate hikes will follow towards the end of the year. It remains to be seen how the ECB will react at its next meeting. While three central bank governors are calling for an increase of 0.5 percentage points, others are still on the brakes.

(“Die Presse”, print edition, May 27, 2022)