With rates near peak, ECB focus shifts to growth, bond spreads

By Balazs Koranyi and Francesco Canepa

MARRAKECH/FRANKFURT (Reuters) -European Central Bank policymakers expressed cautious optimism on Thursday that inflation was on its way back to 2% even without more rate hikes and raised pressure on governments to maintain the sort of fiscal discipline needed for a soft landing of the economy.

The ECB raised its key interest rate to a record high of 4.0% last month but signalled that its 10th hike in a 14-month-long effort to bring down inflation may be its last, at least for now, as the economy was slowing and could even dip into recession.

Joining an already long list of policymakers suggesting steady rates for now, French central bank chief Francois Villeroy de Galhau and his Greek counterpart, Yannis Stournaras both planed down the need for further tightening, arguing that policy was already in a setting that could lower inflation.

Those comments came just as the accounts of the ECB’s last meeting, published on Thursday, showed that even the last hike was a close call, with tactical considerations tipping the scale towards the increase.

“Erring on the side of pausing the first time the decision was a close call could risk being interpreted as a weakening of the ECB’s determination, especially at a time when headline and core inflation were above 5%,” the ECB said.

While a solid majority backed the increase, there was also a shift in the perception of risk with policymakers seeing risks to inflation more balanced and they also saw a greater balance between the cost of tightening too much and too little.

The ECB’s models also suggested, according to the accounts, that a deposit rate in the region of 3.75% to 4.00% could bring inflation back to 2%, provided the ECB held this level long enough.


With rates already at a record high and inflation on the way down, policymakers appeared to shift their focus to growth, the potential for a recession and fiscal issues.

“If we can follow a monetary path which ensures a soft landing… it’s a much better route for our fellow citizens,” Villeroy told a conference in Marrakech.

Stournaras meanwhile noted that borrowing costs had already risen since the ECB’s last policy meeting as a result of higher bond yields, so he questioned if even more tightening was needed, whether via fewer bond purchases or higher charges on banks.

These higher borrowing costs are a particular risk for Italy as investors see the country as especially vulnerable, given its high budget deficit, high debt and lack of fiscal discipline.

Stournaras played down worries about Italy but also made the case against the ECB ending early reinvestments in its 1.7 trillion euro ($1.80 trillion) Pandemic Emergency Purchase Programme, its first line of defence against a sharp rise in borrowing costs.

“The situation in Italy does not raise any particular worries at the moment,” Stournaras added.

Long-term bond yields have risen significantly since the ECB’s last meeting as investors prepared for an era of still large budget deficits and reduced or no buying from central banks – a possible headache for big borrowers like Italy.

Borrowing costs have eased slightly this week on the back of Federal Reserve officials talking down the need for further U.S. interest rate increases and nervousness about the Israel-Hamas conflict spreading more widely in the Middle East. [GVD/EUR]

“This movement of spreads is in a way a reminder to governments that coordination between fiscal and monetary policy is necessary,” Slovenian central bank chief Bostjan Vasle said.

“Fiscal discipline is needed to protect spreads,” Vasle said, referring to the premium countries have to pay to borrow.

($1 = 0.9446 euros)

(Reporting By Francesco Canepa; editing by Balazs Koranyi and Susan Fenton)