Hawkish ECB comments push up rate-hike expectations

By Leigh Thomas and Francesco Canepa

PARIS/FRANKFURT (Reuters) – European Central Bank interest rates still have some way to rise, two influential policymakers said on Friday, pushing up market pricing for the peak rate and helping to unwind benign expectations after the last policy meeting.

ECB board member Isabel Schnabel and French central bank chief Francois Villeroy de Galhau, among the most influential voices on the 26-member Governing Council, both highlighted their fears about stubborn underlying inflation and pushed back on market pricing for interest rates.

The ECB has lifted its key interest rate by 3 percentage points since July and promised another big move in March but markets began to doubt its resolve earlier this month, perceiving some of its guidance as vague and non-committal.

“Markets are priced for perfection,” Schnabel, the head of the ECB’s market operations, told Bloomberg. “But there is a risk that inflation proves to be more persistent than is currently priced by financial markets,” she said.

Schnabel, who is seen as the most influential among the ECB’s “hawks” who favour higher rates, also said the central bank may need to “act more forcefully” if it found that the economy’s reaction to its tightening was weaker than in the past.

Money markets now show investors betting on a peak ECB rate at around 3.75% by late summer, up from levels around 3.4% earlier this month, as a string of hawkish ECB comments in recent days unwound earlier bets.

Villeroy added his voice to this chorus, saying that the peak for rates could be as far away as late September and that the ECB’s deposit rate, now at 2.5%, was likely to exceed 3%.

He also pushed back on market pricing for a rate cut by the end of the year, saying that once rates peak, they need to stay there for some time.

“We need to be wary of declaring victory too soon,” Villeroy said in a speech. “This issue (of rate cuts) is of course further off in the future, and definitely not for this year.”

Market expectations ‘too volatile’

As a spate of strong economic data prompted investors on Friday to rethink how high rates could go around the world, Villeroy said market expectations since Thursday appeared to be “excessively volatile”.

The two differed slightly on neutral rates, with Villeroy saying euro zone rates had passed the point where their impact on the economy was neutral and were already in “restrictive territory”, while Schnabel said further evidence was necessary.

And while Villeroy said there was no sign of a turnaround in underlying inflation, Schnabel argued that even a turnaround would not be enough on its own to warrant a reversal from the ECB.

The ECB’s chief economist Philip Lane, who is often at odds with Schnabel, on Thursday listed a number of reasons why the central bank’s moves may not filter through as forcefully as before but argued that this required an “open mind” about future steps.

He and fellow board member Fabio Panetta said the impact of many of the ECB’s rate hikes so far had yet to be felt by the economy, with the latter calling for “small steps” going forward.

The ECB raised rates by 50 basis points this month and pre-announced another increase of the same size for March 16.

But it kept an open mind about future moves, with most policymakers expecting another rate hike in May.

(Reporting By Francesco Canepa, Balazs Koranyi and Leigh Thomas; Editing by Toby Chopra and Hugh Lawson)