The European Central Bank on Thursday opened the doors to a potential eurozone rate hike in the second half of this year as it brought forward the end of its asset purchasing programme to the summer, but at the same time it made clear that it would keep open its option to renew the programme if economic conditions worsen because of the war in Ukraine and sanctions against Russia.
The ECB said the Russian invasion of Ukraine is “a watershed for Europe” and that it will “ensure smooth liquidity conditions”. “The Governing Council will take whatever action is needed to fulfil the ECB’s mandate to pursue price stability and to safeguard financial stability,” the bank said.
ECB President Christine Lagarde said the governing council of the ECB tried “to deliver a predictable course” amid ongoing uncertainty over the impact of the war in Ukraine. She underlined that the ECB is working with an “adverse” scenario and a “severe” scenario towards its baseline projections for the next three years.
“Adding uncertainty to an uncertain situation would not have been the right answer,” Lagarde said. “Added uncertainty. Added optionalities. We try to have as much optionality in order to deal with this situation. We want to have as much optionalities as possible. We recognise that there is huge uncertainty. We keep all the options open, and we will proceed step by step.”
Doves and hawks flying into different directions
At the ECB press conference, Lagarde explained that opinions diverged among the members of the governing council over the course to follow. She said that some council members believed that the ECB should not take action, while others urged to proceed with changes to monetary policy without attaching new conditions. In the end, the ECB’s council agreed on bringing forward, for now, its programme of asset purchased.
Monthly net purchases under the ECB’s asset purchasing programme, or APP, will amount to 40 billion euro in April, 30 billion in May and 20 billion in June. The calibration of net purchases for the third quarter will be data-dependent and reflect its evolving assessment of the outlook, the ECB said in its statement.
Future is data-dependent
Lagarde made clear that today’s decision does not mean the programme will be phased out completely. It said that this will depend on new inflation data and other data that shows how the Eurozone economy is affected by the war in Ukraine and the
” The APP decision is conditional. It clearly states that we have a declining pace of purchases for Q2. For Q3, if the outlook for inflation is confirmed by data, we will indeed end purchases. If on the other hand this data do no support… as we see it now, we stand ready to revise, both in terms of timeline and in terms of purchases. So it is a conditional decision,” said Lagarde, adding that the ECB is “confirming our step by step approach”.
After being reluctant for much of 2021 to support conclusions from economists that point towards inflation, the ECB on Thursday raised its inflation outlook for 2022 to a year-on-year increase in prices of 5.1 percent for the Eurozone, compared to an earlier outlook of 3.2 percent. For 2023 and 2024 it now expects prices will rise respectively by 2.1 percent (1.8 percent earlier) and 1.9 percent (1.8 percent earlier.)
While critics point to strong inflation - Italian producer prices on Thursday were officially reported as being a staggering 32.9 percent higher in January compared to the same month a year earlier, the ECB still believes that inflation will be close to its target rate of 2 percent over the medium term. The governing council “judges that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at two per cent over the medium term.”
High prices may weaken demand
“Energy prices will remain high for longer than expected,” said Lagarde. “If demand were to weaken over the medium term this could also affect prices.”
Some ECB watchers expect to hear a more hawkish tone from Frankfurt during the coming months.
“The ECB struck a distinctly hawkish tone, suggesting that they are more worried about European inflation numbers than market conditions at the moment. If the ECB follows through with accelerating the asset-purchase wind-down, investors could soon find themselves in a new market environment, one without central banks providing a safety net,” said Wolfgang Bauer, Fund Manager at M&G’s Public Fixed Income Team.
The ECB “opened the door at least a little for a possible first rate hike in late 2022,” German private bank Berenberg said in a note to investors. “As we expect underlying inflation to remain more persistent than the ECB does, we look for the ECB to turn more hawkish over the summer and go for a rate lift-off in December 2022.”
The ECB’s economic growth rate for the eurozone was lowered to 3.7 percent for 2020 against an earlier outlook of 4.2 percent.
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