Outlook for the ECB’s monetary policy

Many in the market might have been upset by a lack of forward guidance and may also suspect that the lack of pre-commitment rules out another rate cut next month. For its part, the Standard Bank welcomes the ECB’s decision to stay quiet on its next step, but also believes that this silence does not rule out another cut in rates in October.

The ECB often likes to use what are seen as pre-commitments to signal future policy changes. It is not the only one: the Federal Reserve does the same, as we found out again recently when Fed Chair Powell and others told us that the time has come for the Fed to cut. Such pre-commitments might appear to be welcome as they bestow a degree of clarity to the policy outlook. But we don’t like them.

The only two instances where the Standard Bank thinks such pre-commitments are advisable occur when either the commitment itself serves a monetary policy purpose, or the market is in such a febrile state that it needs to be calmed by a clear pre-commitment. Neither of these two situations exist in the euro zone at the moment – and don’t in the US either, for that matter.

The first justification for a pre-commitment became apparent after the global financial crisis when policy rates fell to zero, or near zero, in many countries. For then it was not possible to lower rates any further, and so central banks took it upon themselves to essentially pre-commit to the same, or lower, policy rates over an extended period of time in order to drive further monetary easing via lower bond yields. When this was not enough, banks engaged in quantitative easing.

The second, and somewhat similar, justification for pre-commitment comes when central banks pre-commit to a certain rate path because it seems clear that drastic action is needed. For instance, in early 2022 when US inflation had moved up to 8% the Fed not only hiked rates but, in the May 2022 meeting, stated that rates were likely to rise another 50-bps in both the June and July meetings. This was essentially the Fed admitting that it had got inflation horribly wrong and needed not just to hike rates but to pre-commit to even higher rates in the future in order to retain market confidence.

In the current situation, the ECB (and the Fed) do not have policy rates at the lower bound, and hence they do not need to commit to rate cuts in order to bolster monetary easing as they did after the financial crisis. Also, it does not seem that they have misjudged the fall in inflation so much that they need to commit to much lower rates in the future in order to restore market confidence.

In short, the ECB, for one, is in the midst of what we might call a ‘normal’ monetary policy cycle, and, in our view, this does not call for pre-commitments about future policy. ECB members discovered the pitfalls of such pre-commitment back in June when members felt compelled to go ahead with a ‘promised’ rate cut even though data on inflation and wages subsequent to the commitment suggested to some that the Bank was making the wrong policy choice.

From here, the Standard Bank suspected that the ECB won’t make any pre-commitments, but will cut rates. Hopefully, this should mean that every ECB meeting is a ‘live’ one in terms of a possible rate cut, as opposed to a situation where pre-commitments might tie the ECB’s hands to a cut once a quarter.

“We feel that the ECB should, and will, use the flexibility it derives from the no-commitment decision to cut rates again at the October meeting. If it does not, we’d see a 50-bps cut in November, not another 25-bps. Before then, we have the Fed’s ‘committed’ rate cut next week to look forward to, and that’s probably going to be 25-bps. From there we hope, and expect, that the Fed too will drop the pre-commitment idea in favour of a more flexible approach that leaves all meetings ‘live’ for rate cuts. This, in turn, should help the Fed push rate cuts through at a faster pace than the market is currently expecting,” said the Standard Bank.