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ECB policymakers converging on 25-bps rate hike in May

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European Union flags flutter outside the European Central Bank (ECB) headquarters in Frankfurt, Germany, April 26, 2018. REUTERS/Kai Pfaffenbach/File Photo

European Central Bank policymakers are converging on a 25 basis point interest rate hike in May, even if other options remain on the table and the debate is not yet settled, according to five sources with direct knowledge of the discussion.

The ECB has raised rates by at least 50 basis points each at six successive meetings — the fastest pace on record — to fight stubbornly high inflation. But a host of factors now support the case for increased caution, the sources, who declined to be named, told Reuters.

Uncertainty remains high after last month’s financial sector volatility and past rate hikes have yet to work their way through the economy, so less is needed because past moves are still taking hold, the sources said.

They added that the peak in rates is now in sight and that this “last mile” is safer to navigate in smaller steps. Another argument put forward for gradualism was that the ECB’s deposit rate, now at 3 per cent, is at a level which restricts growth.

The sources said the debate was still open and the outlook could still change – especially on April inflation data and the ECB’s quarterly bank lending survey, both of which are due just two days before the May 4 meeting.

An ECB spokesman declined to comment.

Some of the sources said they would prefer the ECB not to provide any guidance about its June move, the same way it is keeping its options open now, so that policymakers would have a free hand in acting on the new economic projections due then.

The sources said that some are advocating no change in May – mostly the same Southern European policymakers who did not support last month’s 50 basis point increase, while others – also a small group – argue for another 50 basis point hike.

So far only few policymakers have publicly commented on the possible size of the ECB’s next move.

Klaas Knot of the Netherlands said it was unclear whether 50 basis points would be needed or if 25 was enough. Slovakia’s Peter Kazimir said the ECB could perhaps slow down the pace of its increases while Austria’s Robert Holzmann meanwhile backed another 50 basis point move.

Markets currently price 25 basis point hikes each in May and June, while a third such increase is fully priced in by September.

The sources reasoned that rate hikes are needed because overall inflation remains too high and core inflation – stripped of volatile food and energy prices – could rise for several more months, thus making any pause the wrong signal to send.

French central bank chief Francois Villeroy de Galhau made a similar point on Wednesday, saying that a “turnaround in the trajectory of underlying inflation” should be a trigger for the ECB to level off interest rates.

The sources added that wage growth remained an oversized concern because labour markets are tight and that could easily fuel big demands from workers who lost a large portion of their real earnings in the past two years.

Last month’s banking turmoil only had a modest impact on the euro zone so the economy continued to perform along the baseline outlined in the ECB’s March projections, which were based on market expectations of more rate hikes.

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