Dhe European Central Bank (ECB) is paving the way for a turnaround in interest rates – but still leaves a lot of leeway for possible reactions to the consequences of the Ukraine war. As the Governing Council of the ECB, the central bank’s top monetary policy body, announced on Thursday after its interest rate meeting, the central bank’s bond purchases may be ended sooner than planned.
The third quarter of this year is mentioned, i.e. the period from July to September. There could be interest rate hikes “some time” after that. The central bank replaced the word “shortly” with “some time after” in its terminology for the time of the first interest rate hike after the end of the bond purchases.
ECB President Christine Lagarde emphasized that this would give the ECB more leeway as to how soon key interest rates would be raised after the end of bond purchases. “Some time later” could mean the week after or months later. They don’t want to set an exact schedule, but rather react “data-driven” – depending on how the economy develops in connection with the Ukraine war.
The ECB now intends to double monthly bond purchases as part of the APP program to EUR 40 billion in April. The central bank plans to invest EUR 30 billion in May and EUR 20 billion in June. In the third quarter, fresh security purchases could end altogether, depending on the situation. Originally, the ECB did not want to reduce the APP purchase volume again to 20 billion euros until October 2022.
ECB raises inflation forecasts
After the sharp increase in inflation rates in the euro area from 5.1 percent in January to 5.8 percent in February, the ECB has now revised its forecast for medium-term inflation upwards. In December she had estimated 3.2 percent for the current year, now she is assuming 5.1 percent. In 2023, the inflation rate is expected to be 2.1 (instead of 1.8) percent and then drop to 1.9 (instead of 1.8) percent in 2024. In return, the central bank lowered its forecasts for economic growth. For this year, she now expects 3.7 instead of 4.2 percent.
The increase in energy prices, the main cause of inflation, is stronger than expected and is driving up other prices, Lagarde said. Food has also become significantly more expensive. In the case of wages, on the other hand, no stronger increase has been observed so far.
The ECB emphasized the strong recovery of the economy from the pandemic so far. However, Lagarde also highlighted the additional risks posed by the Ukraine war. For inflation, the consequences of the war could mean risks in both directions: in the short term, inflation will certainly rise due to higher energy prices, but in the longer term higher energy prices and uncertainty could also weigh on demand in the euro area. Lagarde explained that there were different views in the Governing Council: “We had very intensive discussions about the current economic situation, about the prospects, about the uncertainty.” Some council members originally did not want to change anything, others wanted to make changes without conditions . Ultimately, the Council agreed on a package that would give the ECB “maximum agility and flexibility” in times of uncertainty.
The central bank is in talks with the European Union and other political institutions about possible further support for the institutions and people of Ukraine, said Lagarde. This could also involve instruments such as additional swap or repo lines, i.e. currency swaps or credit transactions against collateral.
Economists’ reactions varied. Some called the ECB’s decision “hawkish”, i.e. strongly in the direction of a tighter monetary policy, others “too hesitant”. Jens-Oliver Niklasch of Bank LBBW said he reads the ECB’s announcements as meaning that it would raise interest rates at the end of the year unless something unexpected happened. “The ECB is determined to tighten the reins on monetary policy in order to counteract the persistence of high inflation,” said Ulrich Kater from Dekabank: “This is subject to the condition that the Ukraine war remains economically tolerable for the economy.”