Frederik Ducrozet, Head of Macroeconomic Research Pictet Wealth Management

While the Italian political saga continues, the focus has shifted back to the ECB’s decision on policy rates tomorrow following a Reuters article suggesting that a 50bp hike could be considered despite the ECB’s explicit guidance for a 25bp move.

There are reasons why we should take this story seriously. It was confirmed by other senior sources creating the impression of a coordinated push for a 50bp hike, as opposed to the Governing Council members who made this point individually in the past (including the most vocal hawks from smaller Eastern European countries). Moreover, the very unusual timing of the news, a couple of days before the policy meeting, could reflect last-minute negotiations in the context of the anti-fragmentation tool but also a shifting momentum within the Governing Council. Either way, it will out President Lagarde in a difficult situation, having tried to silence such ‘sources’ in the past.

On balance, we still think that the ECB should hike by 25bp as a first step, but we see three possible drivers of a last-minute surprise.

First, the hawks may have orchestrated the push to send a signal, not so much about the July decision but rather in terms of future rate hikes. They know that downside risks to growth are rising and that they could be stopped out in the normalisation process. This week’s media story could be followed by similar initiatives to press on harder for larger rate hikes in the future. We have argued for a while that a 75bp hike could be discussed in September unless the macro outlook deteriorated further.

Second, the push could be part of the ongoing negotiations over the anti-fragmentation tool. A 50bp surprise hike could have been floated as a concession to the hawks in return for a bolder backstop. We’re not convinced but if that was the case, it could be good news for markets. And if the ECB delivers 100bp of rate hikes in two meetings, the sequencing doesn’t make a big difference in the end.

Third, it could be that the Governing Council received early evidence of a large increase in inflation expectations from the ECB’s Survey of Professional Forecasters (SPF), and that they will use this data to justify a 50bp hike. This is a risk we’ve highlighted before (Lagarde mentioned the SPF during the April meeting), and the worst case for markets facing a possible surprise tomorrow.