The minutes of the December meeting of the European Central Bank (ECB) released on Thursday (19th) showed that members of the European Central Bank believe that the stability of interest rate hikes and the time for maintaining interest rates in a restrictive range are more important, and some members tend to speed up the reduction of balance sheets (QT) pace. The European Central Bank slowed down the pace of interest rate hikes to 2 yards (50 basis points) last month as scheduled, and plans to start shrinking its balance sheet in March.
In terms of monetary policy, the European Central Bank deepened its disagreement on raising interest rates by 2 yards or 3 yards (75 basis points), and many members initially expressed their preference to raise the key interest rate of the European Central Bank by 3 yards.
Some members believe that a rate hike of less than 3 yards will send the wrong message and may be seen as inconsistent with the 2% inflation target. A 3 yard hike speaks for itself and is preferable to the alternative of relying on a 2 yard hike and increased communication along the way.
Cutting rates too quickly could split the bond market and make further rate hikes more difficult. From this point of view, a moderate rate cut rate is more appropriate, especially considering that the impact of shrinking the balance sheet on inflation may be limited.
Nonetheless, a majority of committee members backed Chief Economist Lane’s proposal to raise the ECB’s key interest rate by 2 yards, which would allow the committee to tighten monetary policy for a longer period of time, with current forecasts for 2025 Inflation expectations are not significantly off the 2% target.
The minutes of the meeting showed that the current need to reverse the slowdown in rate hikes priced in by the market, while focusing on uncertainties surrounding economic conditions and the outlook for inflation. However, when interest rates enter a restrictive range, the ECB must be careful not to suppress demand too much, thereby exacerbating recession expectations. As for balance sheet reduction, some members expressed a preference for a faster reduction in the asset purchase program portfolio.
Moderate inflation raises doubts about tightening path
In terms of inflation, the ECB members’ overall assessment of the risks to the inflation outlook is mainly upside, with the latest data showing that inflation is becoming more widespread and persistent. Despite an unexpected drop in headline inflation in November last year, inflation remained higher than expected in September.
ECB officials pointed out that even if headline inflation falls sharply during 2023 (mainly due to base effects), the same is unlikely for core inflation, which remains relatively strong on a monthly basis. Core inflation in 2023 will be more persistent, well above the 2025 target, increasing the risk that inflation will become entrenched in the economy.
It is worth mentioning that the recent strengthening of the euro constitutes a noteworthy change in the external environment, which may mean that inflationary pressures in the euro zone will be reduced for some time to come.
In addition, slowing inflation and plummeting energy prices have made people question the idea of continuing to raise interest rates by 2 yards after February. The ECB has tightened monetary policy more aggressively than at any point in its history, though given that policymakers are turning their attention to record growth in core inflation.
