ECB heralds a new political era with an interest rate path to combat inflation


The European Central Bank will usher in a new era of monetary policy this week as officials complete their turnaround to counter the threat of runaway inflation.

With new forecasts and prices rising at a record pace, President Christine Lagarde and her colleagues will end trillions in asset purchases and pave the way for an exit from eight years of negative interest rates.

While consumer prices rising more than four times the 2% target are alarming enough, it is the outlook beyond the immediate term that will underpin the shift. Their forecasts should show that inflation will not fall below the target again until 2024.

These new quarterly figures will be the first to fully account for Russia’s war in Ukraine, which, no matter when it ends, will have a lasting impact on energy and food costs. The new reality will show that the ECB’s criteria for raising interest rates have finally been met – allowing it to join the Federal Reserve and its peers in raising the cost of borrowing.

“With the forecast, they can show that their three conditions are met” to start unwinding stimulus, said Karsten Junius, an economist at Bank J Safra Sarasin in Zurich. “You can really close the old chapter and face the new threats.”

These challenges stand in stark contrast to the pre-pandemic picture, when officials battled sluggish consumer price growth that fell far short of their target – a situation ECB researchers attribute to past crises, demographics, globalization and digitization.

The turnaround was dramatic. Inflation now exceeds 8%, driven by energy costs and logistical problems. Even when these problems are overcome, the “disinflationary momentum of the last decade is unlikely to return,” according to Lagarde.

Economists polled by Bloomberg expect inflation to come in at 2% in 2024, up from just below that level in March. This would meet the ECB’s demand that price growth not only accelerate in the short term, but remain elevated in the medium term.

The result will be a first rate hike in more than a decade in July after net asset purchases ended. By how much is the subject of heated debates within the Governing Council, with some wanting a half-point hike.

Most economists only see two quarter point moves – next month and in September. But Bank of America changed its mind last week, forecasting double-edged steps at each of the two meetings.

Lagarde has portrayed Russia’s invasion as a pivotal moment that could prove to be a “tipping point for hyper-globalization” while accelerating the green transition – both implying more permanent inflationary pressures. She has charted a course from sub-zero temperatures through October to a return to more ‘normal’ attitudes.

But although the ECB is acting much more slowly than its peers, some still fear it is moving too quickly as the continent’s pandemic recovery meets the price shock and dwindling confidence in war.

In view of the rising prices for staple foods, almost half of Germans say they have to severely or very severely limit their consumption, according to a survey published last week.

“It seems a priority for this Governing Council to signal that they are taking action on inflation, even though there are risks to growth,” said Evelyn Herrmann, an economist at Bank of America in Paris. “It’s a very one-sided discussion that largely ignores risks that inflation could move in exactly the opposite direction.”

Calls to move slowly in the face of an uncertain economic environment have diminished. But even when they have come – as by dovish board member Fabio Panetta – there has also been recognition that interest rates need to rise from record lows to keep price expectations under control.

Spaniard Pablo Hernandez de Cos, another dove, summed up the change of tone last week, which leaves only the magnitude of the initial rate hike in question.

While he emphasized that policy normalization must be “gradual”, “it is crucial that inflation expectations remain anchored and avoiding any significant indirect or second-round effects that could threaten this anchoring.” ECB heralds a new political era with an interest rate path to combat inflation

Fry Electronics Team

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