Business course

Fearing high inflation, ECB stays on course to cancel stimulus

The logo of the European Central Bank (ECB) is pictured outside its headquarters in Frankfurt, Germany December 8, 2016. REUTERS/Ralph Orlowski

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  • The ECB will maintain optionality and flexibility
  • High inflation is probably the biggest worry
  • A more precise timing for stimuli cancellation is possible
  • Decision at 11:45 GMT, press conference at 12:30 GMT

FRANKFURT, April 14 (Reuters) – The European Central Bank could set a clearer timetable for the unwinding of its extraordinary stimulus package on Thursday, as worries about record inflation outweigh worries about a war-related recession.

The ECB has scaled back its money-printing program for months, but has so far avoided committing to an end date, fearing war in Ukraine and skyrocketing energy prices do not suddenly alter the outlook.

It lags far behind nearly every other major central bank, many of which started raising interest rates last year. In the past two days alone, the central banks of Canada, South Korea and New Zealand have all raised the cost of borrowing.

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For now, the ECB plans to end bond purchases, commonly referred to as quantitative easing, at some point in the third quarter, with interest rates rising “sometime” thereafter.

Approved last month, this loosely worded timetable is already being challenged as opposing forces leave the board of governors tasked with setting rates with a dilemma.

For one thing, inflation is already at a record high of 7.5%, with more increases to come. On the other hand, the bloc’s economy is now stagnating, at best, with the impact of the war affecting both households and businesses.

“Given the high levels of uncertainty, (the ECB) is likely to want to maintain optionality and flexibility,” said Nick Kounis, economist at ABN Amro.

“However, the hawkish tone is likely to intensify, leaving no doubt that the most likely outcome in the coming months is an end to net asset purchases and, therefore, higher policy rates. .”

Indeed, a host of conservative policymakers, including the central bank governors of Germany, the Netherlands, Austria and Belgium, have all argued for higher interest rates, fearing inflation high does not last too long.

In addition to the hawkish scenario, longer-term inflation expectations, a key indicator of policy credibility, have significantly exceeded the ECB’s 2% target, even though wages have yet to respond to rising prices.

HIKE RATE?

So while policy is expected to remain unchanged at Thursday’s meeting, ECB chief Christine Lagarde may come under pressure to signal more forcefully that support will be rolled back in the coming months.

“Lagarde could be hinting at a conditional end to (asset) purchases in June, opening up the possibility of a first rate hike in September,” said Frederik Ducrozet, strategist at Pictet. “Alternatively, it could simply refrain from pushing market prices back, which is consistent with September take-off anyway.”

Lagarde contracted COVID-19 last week but said her symptoms were “reasonably mild”.

Markets are now pricing in a combined 70 basis points of deposit rate hikes of minus 0.5% from the ECB this year, though none of the ECB’s 25 policymakers have called for such aggressive tightening.

The rapidly deteriorating economic outlook is fueling cautious policymakers.

High energy prices are draining household savings and the uncertainty of the war is dampening business investment. Banks also tighten access to credit, as they naturally do during wars, which could deepen the recession.

Political doves, on the other hand, argue that most inflation is the result of external supply shocks, so inflation will naturally decline over time.

In fact, high energy prices tend to be deflationary in the longer term because they dampen growth, so there is a risk of inflation falling too low.

“A key question is whether the flow of Russian energy to Europe will remain smooth. If volume restrictions ensue, we would see a much increased risk of a Eurozone recession, which would likely prompt the ECB to be more cautious,” said UBS economist Reinhard Cluse. mentioned.

Yet, weighing the two opposing forces, the ECB is likely to see greater risk from higher inflation, even as policymakers will continue to act in small increments, standing ready to change course on short notice.

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Editing by Toby Chopra and Kenneth Maxwell

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