MUFG: ECB policy works

26 oktober 2023

Henry Cook, Senior Economist at MUFG Bank, comments on today's ECB meeting.

The ECB left rates unchanged at its October policy meeting, in line with expectations, which almost certainly heralds the end of this rate hike cycle after 450bp of total tightening.

The clear indication from money and credit data is that the transmission of the ECB’s policy tightening is working, and working quickly. The latest ECB Bank Lending Survey, released this week, reinforced that picture with tightening of credit standards and weaker loan demand, and the recent move higher in long-term bond yields will also serve to strengthen the transmission of ECB monetary policy.

The press release noted that the ECB 'will continue to follow a data-dependent approach'. As it stands, there’s very little in the data to justify any further tightening. The evidence that core inflation pressures are easing has continued to mount, and survey data suggesting that the euro area economy is teetering close to recession in H2 this year. So it looks like a case of ‘job done’ on rate hikes now.

Of course, the ECB will want to retain some optionality should a data shock change the outlook. There is a chance that developments in the Middle East could push up oil prices significantly to the extent that the ECB worries about inflation expectations and its own credibility.

Lagarde acknowledged increased uncertainty in the press conference. But we assume that policymakers would look through this sort of supply-side shock given clear evidence of improving dynamics in core inflation and transmission of the current restrictive policy setting to the real economy.

So the ECB has probably now entered a holding pattern. 'We have to be steady' said Lagarde, adding that the debate on timing for any rate cut would be 'premature'. It’s hard to criticise that. After the ECB’s fastest rate hike cycle ever, a period of relative calm and a 'wait and see' approach seems prudent.

In the absence of a shock we’d expect the ECB to leave rates unchanged over coming meetings while policymakers attempt to gauge the speed of the transmission of its monetary policy tightening.

That said, based on money and credit data, the indications are that this transmission is occurring rapidly. With increased gloom around the economic outlook it seems increasingly likely that the holding pattern may not last for that long and rate cuts before next summer are certainly in play.

There was some speculation that the ECB could tweak its balance sheet plans, but the language on PEPP reinvestments was left unchanged: the ECB intends to 'intends to reinvest the principal payments from maturing securities purchased under the programme until at least the end of 2024'.

The rise in long-term yields following increased investor buy-in to the 'high for longer' narrative likely quelled any lingering enthusiasm for further immediate tightening action, even from the more hawkish members of the Governing Council. Lagarde said that PEPP reinvestments were not discussed.

Given the sell-off in bonds and extra pressure on Italian BTP spreads after signs of looser fiscal policy in Italy it seemed unlikely that the ECB would be in a rush to change course on PEPP reinvestments at this meeting. As it stands, PEPP reinvestments remain the first line of defence against fragmentation risks and caution is warranted.