Not everyone is convinced that the European Central Bank will be able to move as slowly as it wants on the path away from extraordinary stimulus.
At least six banks including Nomura International Plc and Barclays Plc predict that President Mario Draghi will raise interest rates as soon as next year. While those forecasts are outliers — most investors and economists only foresee a rate hike well into 2019 — a key rationale is that faster-than-expected inflation will force the ECB’s hand.
Moving at such a pace would be worrisome for the Governing Council, which holds a policy meeting on Thursday at which it’s likely to reiterate its pledge to buy debt until at least September and not increase borrowing costs until well after it stops. Policy makers are fearful of any moves that could rock markets and undermine the euro area’s economy upswing.
“Counter to the consensus, we believe that at some point in the coming months the ECB will rethink its monetary-policy strategy,” said Nomura economists led by Andrew Cates, who predict a 10 basis-point increase in the deposit rate from the current minus 0.4 percent.
“Because there has been no meaningful response from euro-zone inflation in recent months to stronger growth — counter to our expectations — this has prompted many observers to conclude that classic cyclical inflation forces no longer hold. We are not convinced.”
A sudden pick-up in prices would follow years of puzzlingly low inflation across developed economies despite accelerating growth and declining unemployment. The ECB says structural changes in the labor market are partly to blame in the euro area, and that those constraints will only slowly subside next year.
Another reason to move early might be the financial-stability risks of negative rates. Barclays chief European economist Philippe Gudin predicts that the Governing Council will end quantitative easing before the end of 2018, increase the deposit rate by 20 basis points in the fourth quarter, and bring it to zero at the start of the following year.
Any rate hike before his term ends in October 2019 would be something of a victory for Draghi, assuming it doesn’t shake markets too much. He currently faces the possibility of becoming the first ECB president never to increase borrowing costs.
The central bank will publish updated economic projections after Thursday’s meeting, which will extend to 2020 for the first time and so should help set inflation expectations. Bundesbank President Jens Weidmann has said that figures for economic growth will likely be revised up.
Behind the Curve
Bloomberg Economics predicts the outlook for inflation, especially underlying price pressures, will be more muted though. It expects policy makers to extend their bond-buying program again after the latest extension to September, and says borrowing costs won’t be increased before the second half of 2019.
Yet even within the ECB, there are those who see a chance that the inflation outlook could change faster than expected. Executive Board member Yves Mersch argued last week that he and his colleagues should avoid making policy promises that extend too far into the future, in case their monetary setting becomes “suddenly too accommodative.”
“Because of the uncertainties and imprecisions involved in measuring slack and inflationary pressures in the economy, we might find ourselves behind the curve without realizing it,” he said. “This would require a sharp correction of the monetary policy settings in years to come.”