ECB Meeting: expectations for 25-bp hike

ECB officials divided over size of rate hike

The European Central Bank (ECB) is expected to announce a 25-basis-point increase to its main policy rates following the Governing Council's meeting on May 4. Recent statements from ECB members indicate that there is only a narrow base of support for a larger move. Policymakers are likely to have been convinced that a stabilization in underlying inflation and signs of tightening credit conditions justify a downshift from the previous 50-bp hikes.

While some members of the ECB's Governing Council have openly called for a downshift to 25 bps, others seem to be on their side. Bank of Portugal Governor Mario Centeno stated on April 15 that he sees no reason 'whatsoever' to hike by more than 25 bps in May. His Greek counterpart, Yannis Stournaras, also suggested on April 22 that the ECB should soon stop hiking.

Furthermore, centrists within the ECB have indicated that future rate hikes should be limited in size and number. Villeroy de Galhau, for instance, stated in an interview published on April 24 that future rate hikes should be limited in size and number. ECB President Christine Lagarde has also suggested that the ECB has "still a little way to go," while Chief Economist Philip Lane stated on April 18 that he sees a need to hike again, but declined to comment on the magnitude of the move.

The hawks, on the other hand, have refrained from forcefully advocating for a larger move. Dutch Central Bank Governor Klaas Knot noted on April 20 that the April inflation report will determine the size of the hike in May. Similarly, Executive Board Member Isabel Schnabel stated on April 19 that she cannot predict what the Governing Council will decide at its next meeting.

Eurozone inflation hits 7% YoY in April

The latest data from Eurostat reveals that inflation in the Eurozone reached 7% year-on-year in April, which is broadly in line with market expectations, but still a modest acceleration from March. Meanwhile, the core inflation rate decreased by a tenth to 5.6% from 5.7%.

Looking ahead, it is expected that goods inflation will decelerate in the coming months as pipeline pressures recede. Recent wage gains, however, are likely to keep services inflation elevated this year. Core inflation is expected to remain elevated through the summer, largely due to changes in the weights used in its calculation. Afterward, underlying inflation is expected to fall, even if the path down is bumpy.

Despite these expectations, the central bank is expected to compromise by hiking a quarter-point but indicating that there is no plan to pause rates. Core inflation and wage growth are simply way too high, offsetting improvements in the data elsewhere. The tone of the Thursday meeting will be key, and continued strength in services inflation will justify a hawkish rhetoric even if the ECB downshifts the pace of rate hikes.

Similar to the US, however, there are concerns about a potential credit crunch. The ECB's bank lending survey, released on Tuesday, showed a tightening in credit conditions, with the largest tightening in credit standards for the last two quarters since the sovereign debt crisis.

In conclusion, inflation in the Eurozone has accelerated to 7% year-on-year in April, with core inflation falling slightly to 5.6%. While goods inflation is expected to decelerate in the coming months, recent wage gains are likely to keep services inflation elevated. Despite this, the central bank is expected to hike a quarter-point while indicating no plan to pause rates. Additionally, concerns about a potential credit crunch are also emerging.