Two European Central Bank (ECB) officials recently emphasised that the financial institution’s interest rates could still rise. The announcement has increased market pricing for the peak rate and helped to dispel optimistic expectations from the previous policy meeting.
Among the 26 members of the Governing Council, Isabel Schnabel, a board member of the European Central Bank, and Francois Villeroy de Galhau, the head of France’s central bank, both expressed concern over persistent underlying inflation and resisted market pricing for interest rates.
Since July 2022, the European Central Bank has increased its benchmark interest rate by 3% and vowed to make another significant rise in March 2023. However, markets started questioning the ECB’s resolve after judging some of its advice as unclear and non-committal.
According to Isabel Schnabel, head of the ECB’s market operations, “markets are priced for perfection.”
“Yet there is a chance that inflation turns out to be more enduring than the financial markets currently anticipate,” she added.
Isabel Schnabel, regarded as the most important of the ECB’s “hawks” supporting higher rates, also suggested that the financial institution may need to “act more forcefully” if it discovered the economy’s response to its tightening was less robust than in the past.
As a result of a recent series of hawkish European Central Bank pronouncements, money markets currently show investors betting on a peak ECB rate of about 3.75% by late summer, up from levels around 3.4% earlier February 2023.
Francois Villeroy de Galhau joined the chorus, stating that the rate peak might not come until late September and that the European Central Bank’s deposit rate, currently 2.5%, was likely to rise over 3%.
However, he disputed market expectations for a rate reduction by the end of the year, arguing that once rates reach their top, they must remain there for some time.
Francois Villeroy de Galhau warned against prematurely declaring victory in a speech. Rate reductions are a future concern; they are not for 2023.
Investors have been forced to reevaluate how high rates may go due to a string of encouraging economic news, according to Francois Villeroy de Galhau, who said that expectations for the market seemed “excessively volatile.”
Regarding neutral rates, Francois Villeroy de Galhau said that the eurozone rates had already entered “restrictive territory” and were no longer neutral, while Isabel Schnabel insisted that more evidence was required.
Francois Villeroy de Galhau asserted that there was no evidence of a turnaround in underlying inflation. At the same time, Isabel Schnabel countered that even a reversal would not be sufficient to cause the European Central Bank to reverse course.
Philip Lane, the chief economist of the European Central Bank, who frequently disagrees with Isabel Schnabel, listed several reasons regarding why the central bank’s actions might not have the same impact as before but argued that this necessitated keeping an “open mind” about potential activities in the future.
He and fellow board member Fabio Panetta said that the economy has not yet felt the effects of several rate increases made by the European Central Bank up to this point, with Fabio Panetta urging “small steps” moving forward.
In February 2023, the European Central Bank increased rates by 50 basis points, and on March 16, it pre-announced another hike of the same magnitude.
Although most officials anticipated another rate hike in May 2023, they maintained an open mind about potential future actions.