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ECB as hawkish as Fed at Jackson Hole

  • While attention has understandably focused on Fed Chair Jerome Powell’s Jackson Hole speech made last Friday, there were also important interventions over the weekend by ECB policymakers. These suggest that the risks to our above-consensus forecasts for ECB policy rates lie to the upside.
  • The most substantial comments were by Executive Board member Isabel Schnabel. She spent much of her speech underlining how severe inflationary pressures had become: the economy was experiencing “unprecedented pipeline pressures” while the pandemic and war were “consistently suppressing the level of aggregate supply at a time of strong pent-up demand”. For the first time in decades, she said, central bankers needed to prove how determined they were to protect price stability.
  • Schnabel highlighted the rising share of people who expect inflation to be well above the ECB’s 2% target and noted that there had been a similar shift in the “right tail” of inflation expectations in the 1970s. She also suggested that the increase in expectations among the “financially literate” parts of the population may be due to concerns about fiscal dominance.
  • According to Schnabel, central bankers have to choose between the “path of caution” and the “path of determination”. Echoing Jerome Powell (see here), she argued that a cautious approach risked repeating the mistakes of the 1970s.
  • Schnabel outlined several reasons to follow the path of determination and tighten policy aggressively. But in essence, she thinks there is a danger that high inflation becomes entrenched and views the risk of doing too little as greater than the risk of doing too much. The ECB should therefore pursue tighter monetary policy “even at the risk of lower growth and higher unemployment.” Indeed, she believes the costs of disinflation may be higher than during the 1980s because the Phillips Curve has flattened since then.
  • The other notable intervention at Jackson hole was from the Governor of the Bank of France, François Villeroy de Galhau. He also stressed the need for determined action in the near term, if only to avoid more “brutal” rate hikes further down the line. Tellingly, he suggested that it was now more important for central banks to be “orderly” than to be gradual in order to avoid undue market and economic volatility. Exactly what an orderly approach means in practice is not clear, especially as the ECB is downplaying the role of forward guidance, but the key point is that he is no longer so committed to moving gradually.
  • Several other policymakers have floated the idea of a 75bp hike at the next ECB meeting on 8 September, whereas the consensus among economists was for just 50bp. Neither Schnabel nor Villeroy de Galhau said what they will favour at the next meeting: they may want to see euro-zone inflation data for August and the ECB’s revised economic forecasts before deciding. However, their comments suggest that a 50bp hike is the minimum to be expected and that 75bp will be seriously discussed.
  • We will firm up our forecasts in our ECB Watch to be published later this week. But whether or not we revise our forecasts, the remarks by policymakers over the weekend suggest that there are upside risks to our current forecast (which is now broadly in line with the market pricing) that the deposit rate will rise from zero now to 1.25% by the end of the year and a peak of 2% next year.

Andrew Kenningham, Chief Europe Economist,