Written by Tomasz Wieladek, chief European economist at T. Rowe Price
Despite the market turmoil surrounding the collapse of SVB, we are likely to see a 50bps hike announced at this week’s ECB meeting.
Firstly, core CPI inflation data have significantly surprised to the upside. Many forecasters now see core CPI inflation sticky at current levels, with some arguing it could reach 6% before summer, at which point CPI inflation is likely to pivot lower. These elevated spot inflation prints will keep the ECB in hawkish mode, despite current market instability.
There are also important financial stability reasons for the ECB to stick to a 50bps hike this week. While President Christine Lagarde clarified that an ‘intention’ to hike by 50bps is not a pre-commitment, she also stressed it would require an extreme scenario for the ECB not to follow this intention. If the ECB hikes by 25bps, this will send a signal to financial markets that euro Area banks could be vulnerable to similar risks as the US banking system. The ECB must stick to its previously communicated script if it wishes to avoid spooking the market.
A data-driven approach
As is often the case, there are many complicating factors as we look forward. Medium term inflation expectations have fallen from 3% to 2.5%, which will support the doves’ view that monetary policy is already tight enough.
Looking at euro area households, the macro financial ecosystem is already under some stress. However, credit demand and lending conditions for firms has not deteriorated by nearly as much as in previous downturns.
Finally, any contagion from the SVB to the European banking system could lead to a credit crunch, which would push the economy into a recession. Also, risks from another gas price spike during the summer, when countries typically refill storage for winter, remain. These factors mean the ECB will be significantly vaguer about its future monetary direction. It may even say it is switching to a data-driven approach, to borrow from Fed-speak.