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Draghi’s ECB Consigned to History as Hawks Seize Policy Controls

·4 min read
Draghi’s ECB Consigned to History as Hawks Seize Policy Controls

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For the first time in a generation, hawkish officials are taking control of the European Central Bank’s steering wheel.

What began as a lone push by Klaas Knot of the Netherlands little more than three weeks ago -- to consider a half-point interest-rate hike -- has morphed into a whole new campaign of monetary tightening for the euro zone, as unveiled by President Christine Lagarde on Thursday.

Short of immediate action, the combination of an imminent end to bond purchases and promises of two increases in borrowing costs, including a likely 50-basis point move in September, amounts to a major victory for the predominantly northern European contingent of officials fretting about record inflation.

The change of course not only marks a shift in the assessment of the price threat bearing down on the region, but also a re-balancing of power within the Governing Council.

A whole coterie of officials whose opinions favoring more restrictive policy were frequently disregarded when Mario Draghi was in charge now seem to be holding sway -- drawing a line under an era in which the former president’s stance largely dominated.

“It’s the hawks winning all the positions, just like the doves did for many years,” said Karsten Junius, chief economist at Bank J Safra Sarasin Ltd. “It’s definitely the hawks that prevailed and have pushed Lagarde. The 50 basis-point commitment is something that we have never seen.”

Such a rate increase -- reminiscent of the US Federal Reserve’s move in May -- is now effectively baked in to the ECB’s policy path. As currently communicated, all that’s needed for it to transpire is for the inflation outlook to remain as bad or worse than officials currently reckon.

Also significant is the effective pledge entailed in the decision for consecutive moves at the coming two meetings. That amounts to the sort of “pre-commitment” that former President Jean-Claude Trichet, who led the ECB for much of the first decade of the century, used to eschew.

For the eight years that his successor, Draghi, was at the helm -- until 2019 -- hawkish officials such as Knot and then-Bundesbank President Jens Weidmann consistently found their views fell on deaf ears. Contrast that with how the Dutchman and colleagues from Germany, Austria and others are shifting the needle.

“Inflation in the euro zone won’t slow on its own,” Weidmann’s replacement, Joachim Nagel, said Friday.

Meanwhile, the formidable Italian influence at the ECB -- where the most senior staff official in charge of crafting monetary policy is Massimo Rostagno, a fellow countryman that Draghi appointed -- now suddenly seems less potent.

Last week, Bank of Italy Governor Ignazio Visco was a voice in the wind calling for “orderly” moves against the push for aggression. And as officials sealed their decision on Thursday, Draghi -- now Italy’s prime minister -- could only speak from afar to make the case for timidity. He insisted record inflation doesn’t reflect overheating and that there’s still spare capacity in the euro zone.

The sudden shift was criticized by Peter Praet, who as ECB chief economist under Draghi was often even more dovish than the president. He said such a change should have been accompanied with better communication on what to do if hiking hurts the integrity of the euro area with a blowout of bond yields of indebted euro members.

“The more hawkish you are on rates also and the more you should clarify the transmission via the country spreads,” he told Bloomberg Television.

No matter what they’ve outlined for coming decisions, ECB officials now face the challenge of following through on their policy against a highly volatile backdrop for growth as well as inflation that could yet deteriorate markedly.

“It’s the easy part to end net asset purchases and to guide for policy rate hikes coming in July and September,” said Piet Christiansen, chief strategist at Danske Bank in Copenhagen. “The tricky part comes in the fourth quarter and beyond, because it’s very uncertain how this will play out.”

(Updates with Bundesbank chief in 10th paragraph.)

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