As inflation persists across Europe, with double-digit numbers for some eurozone countries, ECB President Christine Lagarde’s road map for upcoming interest rates hikes drew a mixed response in the markets.
The European Central Bank on Thursday, in no hurry to raise interest rates while inflation pressures continue to build, took another small step on its journey towards higher eurozone benchmark rate as Lagarde repeatedly underlined the need for flexibility in the bank’s monetary policy.
“We believe that flexibility is helpful. We have seen it being very operative two years ago. Something that is incorporated if warranted,” she told a press conference, adding that it was “premature to say when any flexibility is deployed”.
Lagarde said that the bank’s governing council is increasingly supportive of ending the massive asset purchasing programme it launched seven years ago. A decision on hiking ECB rates generally can only be made once the programme has finished. A formal decision on ending that programme, which currently amounts to 40 billion euro for April, has yet to be made but can be expected at the next ECB meeting on 9 June.
‘Sticking to sequence agreed’
“We are sticking to our sequence agreed,” Lagarde told a press conference. This means completing the asset purchase programme first, and then, “some time after that” decide on interest rates. That time could be “anywhere between a week and several months,” she said.
With that statement, Lagarde flagged that the widely anticipated ECB’s interest rate hike could come as early as October, or even earlier. After the previous Governing Council meeting in March, Lagarde indicated that it could happen before the end of the year. A rate hike in 2022 would be the first one since July 2011.
Asked why the ECB didn’t accelerate more and if they are “too late” on interest rates, Lagarde said “we are on a journey” that is “moving along.” “The last thing we want to see is inflation expectations of being de-anchored,” she said.
In her comments on Thursday, Lagarde repeatedly stressed the concept of “flexibility” that the governing council now has made part of the ECB’s monetary policy. The word appeared seven times in Thursday’s official ECB statement, against only twice in its statement at the March meeting. When answering questions from journalists, Lagarde used the word more than a dozen times.
Mixed interpretations
After the press conference, ECB watchers drew different conclusions. Pictet’s Frederik Ducrozet said the emphasis on flexibility suggested “that changes to QE programmes could be announced ahead of the first rate hike.”
Ima Sammani, foreign exchange market analyst Monex Europe, noted that there was no indication that rates could be raised before the end of the purchasing programme. “There was speculation that the sequencing of normalisation could be altered,” said Sammani. “That is, the ECB would hint at hiking rates while the balance sheet was still expanding, thus limiting peripheral yield spreads while tightening policy across the region. There was no mention of that in today’s statement.”
“As the ECB maintained a cautious tone even as inflation expectations ramped up further over the last month, markets took this as a slight dovish surprise, undoing some of the hawkish pricing,” Sammani said.
Vytenis Šimkus, senior economist at Swedbank, said that a worsening growth outlook could derail the ECB’s plans, noting that Lagarde has hinted the ECB could step in in case of market fragmentation.
Second-round effects
The absence of significant wage increases in the eurozone, which would be seen as evidence of second-round effects of inflation, supports the ECB’s cautious tone, he said. Lagarde also said that the ECB has yet to see clear evidence that higher energy and commodity prices are pushing up inflation.
Lagarde did acknowledge that surging energy and commodity prices are reducing demand and holding back production. “How the economy develops will crucially depend on how the (Ukraine) conflict evolves, on the impact of current sanctions and on possible further measures. At the same time, economic activity is still being supported by the reopening of the economy after the crisis phase of the pandemic,” she said.
Against that backdrop, the ECB “ will maintain optionality, gradualism and flexibility in the conduct of monetary policy,” she said.
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