ECB shadow boxing carries some dangers

An interesting and potentially dangerous political game is going on in the ECB’s governing council. The monetary hawks - those pushing for higher interest rates - know that their chance has come and are trying to press home the advantage. ECB president Christine Lagarde is being forced to change position but appears to be trying not to lock herself in.

With the threat of a growth slowdown or even recession in the autumn and winter just as interest rates go up, this is tricky territory for all involved. The ECB, after all, has been guilty of making mistakes in the past.

The hawks are being led, in public at least, by Robert Holzmann, the governor of the Austrian central bank, who has pushed for an early move on rates and said an initial move of half a point, rather than the expected quarter point, might be justified. Despite this, the ECB is unlikely to hike interest rates at its meeting early next month, and an increase in July will probably be confined to a quarter point.

However, a half point hike cannot be ruled out and Lagarde said this week that the era of negative interest rates would be over by the end of the third quarter. With the ECB’s deposit rate at minus 0.5 per cent, this indicates that another quarter point rise would follow the initial July one in September.

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Lagarde has been forced to revise her position significantly since the start of the year. Some of this is due to the war in Ukraine and the knock-on impact on energy costs. The case for higher interest rates has been cemented by a spread of inflation more widely across economies.

The core dilemma remains: the reason to hike interest rates is usually to slow economic growth and tame inflation. But inflation this time around is not due to runaway growth or a surge in lending.

The obvious conflict on the ECB board, now out in the open, could intensify if inflation stays high but growth starts to slow rapidly later this year. What happens then?