The ECB has said it considers a spike in inflation to be temporary
The European Central Bank cut support for the euro zone economy by another notch today but promised some continued support for 2022.
With the euro zone’s economy now back to its pre-pandemic size, pressure is mounting on the bank to follow its global peers in turning off the money taps.
But policymakers are worried that stepping back too quickly could unravel efforts to rekindle once-anaemic inflation.
The emergence of the fast-spreading Omicron variant also risks new headwinds for the economy if it leads to reimposed restrictions.
“The spread of new coronavirus variants is creating uncertainty,” ECB President Christine Lagarde told a news conference, citing the fall-out for hospitality and other sectors if new restrictions on activity are needed.
Christine Lagarde added that the global supply chain snags that emerged as demand took off after the lockdowns of 2020 were already holding the recovery back.
“These bottlenecks will be with us for some time but they should ease some time in 2022,” she said.
The ECB also today raised its inflation projections and cut its 2022 growth outlook.
It now sees inflation above its 2% target this year and in 2022 but holding below it in the following two years, in line with its view that the current inflation “hump” will be longer than expected but still transitory.
The President of the European Central Bank, Christine Lagarde, has described the Bank’s new forecasts for inflation as ‘significantly higher.’
Back in September, the ECB forecast that inflation in the euro area would be 2.2% this year and 1.7% next year.
Now the Bank forecasts inflation to average 2.6% this year and 3.2% next year.
By 2023, inflation is forecast to fall back to 1.8%.
During a press conference this afternoon following a meeting of the ECB’s Governing Council, President Lagarde said the higher inflation forecasts were ‘two thirds’ energy prices and the rest was down to supply bottlenecks lasting longer than originally thought and higher demand.
She dismissed comparisons with the approach now being taken by the Bank of England, which raised its rates today, and the US Federal Reserve which indicated last night there could be three rate rises next year.
She said it was difficult to compare the euro area to the UK and US, that it was like ‘a different universe and environment.’
President Lagarde said it was ‘very unlikely’ that the ECB would raise interest rates next year.
However, it will pare back its Pandemic Emergency Purchase Programme (PEPP) next year and bring it to a close at the end of March.
The PEPP is a €1.35 trillion programme to buy up bonds in the open market in order to keep borrowing rates down.
Another bond buying programme, the Asset Purchase Programme (APP) will be maintained to give the Bank ‘flexibility’ to respond to market conditions.
ECB President Christine Lagarde
“The ECB has surprised the market with the relatively contained size of APP monthly purchases going forward, though there are dovish elements in its statement with respect to the reinvestments of the PEPP and the fact that it could be resumed,” said Jane Foley, head of FX strategy at Rabobank.
The ECB said cash maturing from the emergency scheme will be reinvested until the end of 2024, a year longer than previously planned, and funds spent flexibly to help markets in stress.
“This could include purchasing bonds issued by the Hellenic Republic over and above rollovers of redemptions in order to avoid an interruption of purchases in that jurisdiction, which could impair the transmission of monetary policy to the Greek economy,” the ECB said.
Today’s moves leave the world’s two biggest central banks on opposing courses after the US Federal Reserve accelerated its exit from asset buys last night and flagged several rate hikes. Similar divergences have led to market turbulence in the past.
Although the ECB’s “recalibration” will leave asset buys well below their current levels, the effective cut is likely to be much smaller as fresh government issuance will decline, so that the ECB will continue to hoover up most of the new debt.
The bank also maintained its forward guidance on interest rates and asset purchases, which some had expected to be tweaked.
It left its key interest rates unchanged, as expected.
Earlier today, the Bank of England surprised markets with an unexpected rate hike.