By Geoffrey Smith
Investing.com — The European Central Bank speeded up its plans to tighten monetary policy Thursday after admitting that the war in Ukraine would drive inflation higher and hit growth for the next couple of years.
The Frankfurt-based central bank cut its growth forecasts through 2024, and now sees growth of only 3.7% this year, down from 4.2% previously. It sees inflation, meanwhile, at 5.1% this year, rather than the 3.2% it previously forecast.
As a result, the ECB said that it will stick to its plans to end pandemic-driven bond purchases this month and phase out all of its asset purchases in the summer if inflation fails to come down fast enough.
At her regular press conference, ECB President Christine Lagarde said that the sharp rise in energy prices caused by Russia’s invasion of Ukraine is helping inflationary pressures to spread to a much broader cross-section of prices. She added that further increases in inflation – which hit a euro-era high of 5.8% in February – are likely in the near term.
As expected, the ECB said it will temporarily boost the bond purchases under its long-running Asset Purchase Program, which predates COVID-19, to 40 billion euros ($44 billion) in April, falling to 30 billion in May and 10 billion in June. That will cushion the impact of stimulus withdrawal. Thereafter, it said, “the calibration of net purchases for the third quarter will be data-dependent and reflect its evolving assessment of the outlook.”
“If the incoming data support the expectation that the medium-term inflation outlook will not weaken even after the end of our net asset purchases, the Governing Council will conclude net purchases under the APP in the third quarter.”
Lagarde said in her press conference though that the new position didn’t reflect an acceleration of the bank’s tightening plans. She stressed the high level of uncertainty and stressed that the bank will continue to be guided by economic data.
The euro initially rose nearly a cent against the dollar on the news, which took a tougher line on inflation than expected. Many had expected the ECB to signal greater willingness to tolerate high inflation in the short term, given the uncertainty over the economic outlook caused by the war in Ukraine and the West’s response to it.
However, Lagarde’s subsequent comments led the euro to pare its gains. By 9 AM ET (1400 GMT), it was back at $1.1060, half a cent below its intraday high.
The ECB stuck by its previous guidance on its key interest rates, the main one of which remains at -0.5%.
Despite hints by Lagarde at her previous press conference that she was open to the possibility of raising rates later this year, the bank said after its policy-setting meeting that it still expects rates “to remain at their present levels” until it’s confident that inflation can stay durably around its target level of 2% in the medium term. Under the ECB’s new forecasts, which take into account the possible impacts from the Ukraine war, inflation will fall to 2.1% next year and 1.9% in 2024.
“Welcome to ‘team stagflation’,” said ING economist Carsten Brzeski via Twitter, noting Lagarde’s comments that risks to growth were now skewed to the downside, while those to inflation were skewed to the upside.
“The bottom line is that inflation worries dominate,” said Pictet Asset Management analyst Frederik Ducrozet via Twitter. “Forget about the details, forget about changing the sequencing, the hawks want to stop QE when inflation is edging towards 7%.”
The news was badly received by Eurozone bond markets. The benchmark 10-year Italian bond yield rose 20 basis points to 1.90%, widening the spread over its German equivalent to 163 basis points. Analysts are concerned the end of asset purchases will put fresh stress on governments with the biggest debt loads.
The ECB’s statement did contain some comfort, however, for other European central banks. The Frankfurt-based institution said it will extend existing euro swap lines with them until January 2023, providing an important backstop in the event of pressure on central European currencies that have come under particular pressure due to their proximity to Ukraine. That wasn’t enough to stop the overall hawkish tone of the release from pushing the euro higher against the Polish zloty, the Romanian leu and the Hungarian forint, however.
The euro had hit an all-time high against the Polish zloty earlier in the week amid fears for the Polish economy as a consequence of the conflict. That was despite another 25 basis-point increase in the National Bank of Poland’s key rate to 3.5%.
ECB Says Will End Asset Purchases in 3Q if Inflation Doesn’t Come Down