While the Federal Reserve is expected to raise rates aggressively in the coming months, the European Central Bank, fearing the impact on Europe’s weaker economies, will remain reluctant to quickly boost Eurozone interest rates to mitigate the effects of rising prices. The ECB is due to provide a new monetary policy update on Thursday at its next six-week press conference.
ECB president Christine Lagarde, who tweeted last Thursday that she had tested positive for Covid-19, last month opened the doors to a potential eurozone rate hike in the second half of this year. The ECB is bringing forward the end of its asset purchasing programme to the summer, which - in theory - creates the option of an ECB rate hike in the fourth quarter.
The ECB has said Thursday’s monetary policy press conference is scheduled to go ahead, although the exact format remains to be decided.
Meanwhile across the Atlantic, the Federal Reserve has overcome its earlier reluctance to push ahead with rate hikes. A Reuters poll of more than 100 economists projects two half-point rate rises this year, the first such hikes since 1994.
In Europe, a similar poll among 52 economists says 31 expect the ECB to raise rates in the fourth quarter, with ten saying it will happen as soon as July-September, up from six in a poll last month. None expected a rate rise by mid-year, according to Reuters.
‘New inflationary era’
Central bankers worldwide are becoming convinced that the era of low inflation - and low interest rates, is definitely over. Agustín Carstens, general manager of the Bank for International Settlements, in which the world’s leading central banks come together, explained that the extraordinary policy measures to mitigate the economic impact of the pandemic laid the groundwork for a “rapid and goods-intensive bounceback in demand which supply has been unable to fully meet.”
The Ukraine war has further disrupted supply, in particular for commodities.
“We may be on the cusp of a new inflationary era,” Carstens said last Tuesday at a speech in Geneva. “The forces behind inflation could persist for some time. New pressures are emerging, not least from labour markets, as workers look to make up for inflation-induced reductions in real income.”
Carstens also said this experience holds lessons for our understanding of inflation and said there is a need to look “under the hood” of the inflation process. “In hindsight, it was too tempting to dismiss the initial rises in energy, food and car prices as a one-off adjustment to changed demand. We have learned once more that sector-specific shocks can spill into other sectors and become more persistent and pervasive.”
‘Hiking rates unproductive’
Back in financial markets, Mabrouk Chetouane, head of global market strategy bij Natixis Investment Managers, said a possible ECB rate rise at the present time would be counterproductive because the EU’s economy is twice as much more energy intensive than in the US, 9.1 percent for the EU compared to 4.4 percent for the US.
This “significantly increases stagflation pressures for the Old continent. Hiking rates in these circumstances could be unproductive as it would have a limited impact on inflation and negative one on credit,” Chetouane said in a note to investors.
At Pimco, portfolio manager Konstantin Veit noted that headline inflation “surprised meaningfully to the upside” again in March, making a further upward revision of teh ECB’s own inflation projections in June all but certain. Veit believes a first 25 bp rate hike by the ECB in September is “a plausible scenario”.
Bund spreads eyed
Even when eurozone rates remain flat, the ECB’s comments on Thursday will certainly be worth listening to. On Monday, the German 10-year bond yields rose to 0.78 percent, its highest level since 2015, while these were still negative the last time the ECB’s policy-making council met in March.
Citing people familiar with the plans, news agency Bloomberg on Friday reported that the ECB is considering “a special crisis tool”, or “a backstop”, that it could activate in the event that eurozone bond yields, particularly those in weaker eurozone economies such as Italy and Greece, jump.
Such a tool could give the ECB more flexibility to target its policy and repurchasing policies at specific parts of the eurozone. This “flexibility” is particularly important when its repurchasing programme is phased out ahead of possible rate hikes, as has been flagged by ECB chief economist Philip Lane in a speech at the end of March.
By late afternoon on Monday, the yield spread between Germany 10-year bunds and their Italian counterparts on Monday stood at 1.66 percent, down from 1.69 percent at Friday’s close.