Monex Europe: The hawks take flight as Sintra looms

June 27, 2023

The ECB’s annual forum in Sintra will provide important clarity for financial markets, says Simon Harvey, Head of FX Analysis at Monex Europe. With the end of monetary tightening approaching, markets want to understand how and when central banks will be calling an end to their tightening cycles.

According to Monex Europe’s WeekAhead (see attached), the following topics will be the most relevant in Sintra:

Central Bank commentary is likely to skew hawkish, emphasizing data dependence

• Despite hiking once again at last week’s ECB meeting, a move that increased policy rates by 25bps and took the key policy rate to 3.5%, the balance of views heard from ECB speakers has continued to skew hawkish in recent days.
• Whilst it seems likely that most of the doves will continue to stay quiet over the course of the forum, given the weakening data cracks may start to appear in what has up to now been a relatively united front. Many other central bankers seem likely to be similarly hawkish over the course of the event.

The feedback dynamics between wages and inflation are a possible focal point

• With inflation now falling across most countries represented at Sintra, the focus for central bankers has increasingly turned to exactly how much tightening will be needed to squeeze inflation out of the respective economies.
• In particular, concerns of a feedback dynamic between wages and prices that prevents inflation from returning to target, have taken on increasing importance in central bank communications over recent weeks.
• Evidence from literature on the importance of this dynamic is mixed, but policy makers’ understanding of the phenomenon is critical for judging the likely end for each country’s hiking cycle.

The role of fiscal policy looks set to be an unusually prominent topic of discussion

• Another topic likely to set tongues wagging is the role of fiscal policy in fueling inflation. The ECB’s Lagarde in particular has been notable for her interventions, warning national governments that excessive spending will continue to fuel inflation, and necessitate an even tighter policy stance from the ECB. But the intervention by a central banker on what are clearly fiscal matters is unusual, especially outside Europe.
• Whilst an indication that fiscal policy is of course fueling inflation would not be a surprise, the risks of fueling a spat between monetary and fiscal authorities makes this a potential landmine for the central bankers present.

Forecasting inflation: sorry, but what comes next?

• This event offers a chance for central bankers to offer a mea culpa for their forecasting failures. Most interesting on this topic will be the BoE’s Huw Pill, representing the central bank that has arguably got their forecasts the most wrong so far, and has been taking brick-bats publicly in response.
• But just as important will be any steer to the path forwards for inflation across the different countries, and therefore any hints as to the likely evolution of central Bank Reaction functions. With most central banks assumed to be at or close to terminal rates, the evolution of inflationary dynamics will be the ultimate deciding factor on when to call time on their hiking cycles.
• For FX markets, an emergence of ECB doves should help the euro take a leg lower, whilst some dollar upside could be in store if Powell can finally convince markets of his hawkish credentials.