Analysis: The ECB says it is struggling to keep the market on its side after mixed messages
- Investors see an interest rate cut by the end of the year despite ECB guidance
- Analysts say the muddled messages have damaged the ECB’s credibility
- The censure in the letter changed, the cacophony of voices
FRANKFURT (Reuters) – The European Central Bank’s policy signals no longer convince investors whether it is trying to raise or lower interest rate expectations, analysts say.
Two years of turmoil since economies began to open up after the coronavirus has complicated central banks’ communications with financial markets, helping to relay policy moves to businesses and households.
With inflation at multi-decade highs and the war in Ukraine fueling economic volatility, global peers, including the US Federal Reserve and the Bank of Japan, have often struggled to send clear and consistent signals.
But four analysts told Reuters the ECB’s problems in doing so were made more acute by frequent changes in its policy message and what one described as a dissonance among policymakers from the 20 countries that use the euro.
“They simply do not agree in their communication and explanation of the reaction function,” said Carsten Brzeski, global head of macroeconomics at Dutch bank ING.
“The message is constantly changing. That’s why the markets abandoned it.”
A little over a year ago, European Central Bank President Christine Lagarde was trying to convince investors that they were wrong to bet on higher borrowing costs because high inflation would be temporary.
By early February – even before Russia invaded Ukraine – it had recognized the growing inflation risks and the possibility of higher interest rates.
Now, Lagarde faces the opposite problem: Investors won’t believe her when she says the European Central Bank will continue to raise interest rates at a rapid pace to bring inflation down to 2% within two years from nearly five times that level now.
The European Central Bank chief is pushing back, telling investors in Davos last week that they should “review their positions” – adding weight to previous comments from policymakers in the Netherlands and Latvia.
The European Central Bank declined to comment.
“They are doing their best to communicate clearly at the moment, but they are suffering the consequences of going off the curve last year, and that is the price to pay for changing direction as frequently as they did,” Danske Bank economist Piet Heines Christiansen said.
After a few months last year in which it was criticized for not acting as other central banks did, things are starting to look up for the ECB.
An aggressive diet of interest rate hikes that began in July stabilized the euro and raised borrowing costs by the fall – which the central bank said was needed to bring down inflation.
But by December, with inflation showing signs of peaking, recession looming, and ECB chief economist Philip Lane raising the prospect of smaller price moves, investors began to suspect the ECB’s willingness to stick around for much longer. .
It responded by committing at its December 15 meeting to several more rate hikes, though at 50 basis points each instead of 75 basis points in September and October.
Now, with inflation falling and talk of small interest rate increases by the Fed – which often affect other central banks due to the dollar’s status as the world’s reserve currency – investors are once again becoming skeptical.
Money market prices saw the ECB’s deposit rate peak at 3.3% in July – a significant drop from the 3.5% expected at the start of the year – with a cut by December.
Analysts said the ECB cornered itself when Lagarde said last month that she would raise interest rates by 50 basis points at her “next meeting, maybe at the next meeting, maybe after that”.
“With the kind of commitment you make, you lose credibility if you don’t stick to it,” said Dirk Schumacher, head of European macro research at Natixis. That would be a problem for any central bank.”
With the eurozone economy now doing better than expected, he said Lagarde should backtrack on the December pledge.
tug of war
Lagarde’s commitment also baffled ECB watchers because the central bank previously said it would no longer issue such general forecasts – known as forward guidance – but instead make every decision based on the data received.
“They run into a paradox in saying they’re going to a one-on-one meeting while at the same time committing to a rate hike,” said Frederic Ducrozet, head of macroeconomic research at Pictet Wealth Management.
But Danske’s Christiansen said the ECB can’t always just follow investors, especially when situations are volatile.
He added, “The ECB does not have the luxury of changing its view like the markets. This of course leads to a tug of war between the ECB and the markets in the narrative.”
Sources told Reuters last month that Lagarde’s words in December represented a compromise to unify the ECB’s Governing Council. Some members, like Lane, sought to move lower rates while others, like Isabel Schnabel, wanted a bigger movement.
Schnabel and Lane often air their differing views on politics in public, and Lagarde, who is not an economist, has refrained from separating them, seeking instead to reflect the board’s consensus view.
In turn, investors know that a message from Federal Reserve Chairman Jerome Powell can trump the opinions of other policymakers, analysts said.
ING’s Brzeski said the ECB lacks a clear thought leader on its board who can guide markets like Lagarde’s predecessor, Mario Draghi.
“The cacophony of voices and lack of clarity about who is the main voice continues to hurt the ECB,” Brzeski said.
Editing by Catherine Evans
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