The European Central Bank now is convinced that it will raise its benchmark eurozone interest rate at its 21 July monetary policy meeting and said it expects that its interest rates will no longer be negative by September. Its latest statement also indicates that the ECB is hedging its bets for upcoming medium-term policy moves in order to to add to its flexibility to act.
ECB president Christine Lagarde on Monday said the outlook for inflation has “shifted notably upwards” which means an easing of monetary policy by leaving interest rates unchanged “is not currently warranted.” The ECB now is set to end its asset purchasing programme of injecting capital into the economy “very early in the third quarter.
“This would allow us a rate lift-off at our meeting in July, in line with our forward guidance,” Lagarde wrote in a blog post on the ECB website. “Based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter.”
‘Journey down the path of policy normalisation’
The size of the July rate hike is still to be assessed. Some ECB member countries, such as the Netherlands, believe an increase of 50 basis points is warranted, while other countries, especially those facing significant levels of government debt, may be reluctant to endorse such a major rate hike and may opt for a 25 basis point increase.
Lagarde is framing the ECB’s course ahead as a “journey down the path towards policy normalisation”. With the date for the “interest rate lift-off” drawing closer, “it becomes more important to clarify the path of policy normalisation that lies ahead of us – especially given the complex environment that monetary policy in the euro area is facing,” she said.
Elaborating on the concept of “policy normalisation,” Lagarde said that once rates have been raised, the “next stage of normalisation” would need to be guided by the evolution of the medium-term inflation outlook, and that assessing the cause for an overheating economy is complex and difficult to assess accurately.
‘Negative supply shocks’
“The situation we are currently facing is complicated by the presence of negative supply shocks,” she wrote, referring to price increases that are caused by a lack of supplies, as opposed to strong demand that can be curtailed by raising the cost of money.
“This creates more uncertainty about the speed with which the current price pressures will abate, about the evolution of excess capacity, and about the extent to which inflation expectations will continue to remain anchored at our target,” Lagarde said.
“In such a setting, there are arguments for gradualism, optionality and flexibility when adjusting monetary policy,” she said, referring to the concept of optionality to which she has referred also in earlier policy statements made in recent months.
Tools that the ECB used to fight inflation before the pandemic “are no longer appropriate,” Lagarde said. “Policy normalisation has to be carefully calibrated to the conditions we face.”
“While unusual, a good way to anchor the narrative,” said US economist Mohammed El-Erian in a tweet commenting on Lagarde’s blog post.
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