The Council of the European Central Bank (ECB) confirmed the continued expansive course of the central bank at its meeting this Thursday. ECB President Christine Lagarde had repeatedly rejected an imminent rate hike in the euro area. The key interest rate has been at a record low of zero percent for years.
Inflation puts ECB under pressure
Inflation in the euro area climbed to a record high at the start of the year, leaving the ECB in need of explanation shortly before its next interest rate meeting.
Exploding energy prices ensured that inflation in January shot up to 5.1 percent within a year, as the European statistical office Eurostat announced on Wednesday based on preliminary data. This is the highest value since statistics began in 1997. Experts, on the other hand, had expected inflation to fall to 4.4 from 5.0 percent in December. Inflation is thus moving further and further away from the target set by the European Central Bank (ECB), which is targeting a rate of 2.0 percent as the optimal value for the economy.
The financial markets reacted promptly: Speculations about an interest rate turnaround that was now approaching more quickly caused the euro to rise by 0.45 percent to $1.1324 at times. The European banking index climbed 1.3 percent to a three-and-a-half-year high. The money market is now even counting on a slight increase in the deposit rate by the summer. The interest rate has been minus 0.5 percent since September 2019. This means that banks have to pay penalty interest if they park excess liquidity with the central bank.
ECB predicted stable inflation
For the currency watchdogs headed by ECB President Christine Lagarde, who are again setting out their monetary policy course at their interest rate meeting on Thursday, the continuing rise in inflation is likely to come as a negative surprise. Because according to their previous scenario, inflation should stabilize in 2022 and the rate of inflation should gradually decrease. With the January figures, the voices in Germany calling for a speedy departure from the ultra-loose monetary policy that has been in place for years should also become even louder.
According to economists, the pressure on the ECB will increase with the new record high. “The unexpectedly high rate of inflation is a blow to the ECB’s neck,” said Commerzbank chief economist Jörg Kramer. It is miles above the 4.1 percent forecast by the ECB for the first quarter. The central bank should finally recognize the massive increase in inflation risks and take its foot off the gas in terms of monetary policy. Helaba economist Ralf Runde turns his attention to the forthcoming ECB interest rate meeting: “It will be interesting to see whether the ECB President will again emphasize at the press conference that interest rate increases are very unlikely this year.” Economist Jörg Angele from the Swiss bank Bantleon expects that the inflation rate will even be over 5.0 percent by the middle of the year: “The inflation hump much cited by the ECB is getting higher and wider.”
Governing Council confirms end of PEPP net purchases in March
As expected, the Governing Council of the European Central Bank (ECB) confirmed the decisions it made in December to end net purchases under the PEPP pandemic program and to temporarily increase the APP purchase program. The level of policy interest rates and the related forward guidance also remained unchanged and the preferential terms for TLTRO3 tenders are scheduled to expire in June as previously planned.
The Governing Council made the following decisions in detail:
1. Interest rates and forward guidance
The interest rate on the main refinancing operations, the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00 percent, 0.25 percent and minus 0.50 percent, respectively.
The Governing Council expects the key ECB interest rates to remain at current levels or lower until it sees inflation picking up towards its 2% target well before the end of the projection horizon and on a sustained basis for the remainder of that period can. The progress that has already been made in terms of underlying inflation must also be so clearly recognizable that medium-term stabilization of inflation at 2 percent seems plausible. According to the ECB, inflation can temporarily be slightly above 2 percent.
2. PEPP program and forward guidance
Net PEPP purchases are projected to be lower in Q1 2022 than Q4 2021 and ending at the end of March 2022. The PEPP amortization amounts are to be reinvested until at least the end of 2024. The expiry of the reinvestment should be controlled in such a way that an impairment of the monetary policy course is avoided. The ECB can handle the reinvestment flexibly.
Especially in the event of renewed “fragmentation”, i.e. an increase in the yield differentials of government bonds, reinvestment can be made flexibly in terms of timing, asset class and country of origin. This also applies to Greek government bonds, which the ECB is likely to buy beyond pure reinvestment if necessary. A resumption of net purchases as a whole is also possible.
3. APP program and forward guidance
The ECB wants to increase the monthly APP purchase volume from the current 20 billion euros to 40 billion in the second quarter of 2022 and then reduce it again to 30 billion in the third quarter. From October 2022, the net purchase volume should be back at 20 billion euros and stay there for as long as necessary.
Forward guidance continues to indirectly tie APP net purchases to inflation target achievement. They are intended to end only shortly before the first interest rate hike and to continue for as long as is necessary to strengthen the accommodative effect of policy rates. The principal amounts of the APP Securities are intended to be fully reinvested for an extended period of time beyond the date of the first interest rate increase.
4. Funding Conditions
The ECB will monitor banks’ refinancing conditions and ensure that maturing TLTRO3 operations do not disrupt the smooth transmission of monetary policy. She also wants to regularly check how targeted credit operations affect her monetary policy. The special conditions of the TLTRO3 are scheduled to expire in June 2022 as planned. The ECB wants to ensure that its two-tier system of deposit rates is properly calibrated so that the negative deposit rate does not limit banks’ ability to lend.
The ECB is ready to adjust all of its instruments in any direction so that inflation can stabilize at 2 percent in the medium term.
Lagarde: Inflation is likely to remain elevated for longer than previously expected
According to ECB President Christine Lagarde, the Governing Council of the European Central Bank (ECB) still expects inflation to fall in the coming months. However, he sees the inflation risks as skewed to the upside. Lagarde said in the press conference following the ECB Governing Council meeting that inflation is likely to remain high for longer than previously expected. It was again higher than expected in January. However, inflation is likely to fall over the course of the year.
Inflation in the euro zone has consistently been higher than economists had expected in recent months. In January, it rose to a new record high of 5.1 percent instead of declining to 4.3 percent as expected. The main reason was higher energy prices, but food prices also played a role.
“The direct impact of energy prices accounts for more than half of inflation,” Lagarde said. There are also indirect effects. According to Lagarde, the ECB expects energy prices to fall over the course of the year. The bottlenecks in the supply chain are also likely to dissolve.
In contrast to the deliberations in December, according to Lagarde, the Governing Council of the ECB considers the inflation risks to be on the up – “especially in the short term,” as Lagarde said.
In the past few months, ECB officials have repeatedly expressed the expectation that inflation would fall after the turn of the year at the latest. One reason was that the normalization of VAT in Germany would then fall out of the year-on-year comparison. Although this effect was noticeable in Germany, it was not sufficient for the entire euro area.
The ECB is committed to maintaining medium-term price stability, which it sees as given with an inflation rate of 2 percent. From a monetary policy point of view, the currently high level of inflation becomes a problem if it threatens to become entrenched through higher inflation expectations, the price-setting behavior of companies and wage settlements.
In Germany in particular, there have been calls for a “normalization” of the ECB’s monetary policy for some time due to high inflation.
As expected, the Governing Council of the ECB had previously confirmed the decisions taken in December to end the net purchases under the PEPP pandemic program and to temporarily increase the APP purchase program. The level of key interest rates and the related forward guidance also remained unchanged; and the preferential interest rate for TLTRO3 tenders are scheduled to expire in June as previously planned.
Editorial office finanzen.net / Reuters / dpa-AFX / Dow Jones Newswires
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