The European Central Bank faces a difficult balancing act as inflation hits record highs while the war in Ukraine casts a shadow over growth prospects.
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That European Central Bank left monetary policy unchanged on Thursday but confirmed it would end asset purchases in the third quarter.
The ECB said in a statement on Thursday that it now expects to complete its net asset purchases under its APP (asset purchase program) in the third quarter. It had previously said that would be the course of action if the data supported it.
“At today’s meeting, the Governing Council concluded that data since its last meeting reinforced its expectation that net asset purchases under the APP should be completed in the third quarter,” the bank said on Thursday.
Once the bond-buying program is complete, the ECB is expected to start raising interest rates, following the same path as the Bank of England and the US Federal Reserve.
In a press conference following the release of the statement, ECB President Christine Lagarde said that the development of the euro zone economy “will depend crucially on the further development of the conflict, on the impact of the current sanctions and on possible further measures”.
Lagarde noted that inflation “has risen significantly and will remain high in the coming months, mainly due to sharp increases in energy costs”.
Looking ahead, Lagarde said the ECB’s monetary policy will depend on incoming economic data and its “evolving view of the outlook.”
She added that the Governing Council will “take all measures necessary to fulfill the ECB’s mandate to pursue price stability and contribute to safeguarding financial stability”.
The interest rate on the ECB’s main refinancing operations, interest rates on the marginal lending facility and the deposit facility remain unchanged at 0.00%, 0.25% and -0.50%, respectively.
“Any adjustments to the key ECB interest rates will take place some time after the end of the Governing Council’s net purchases under the APP and will be phased in,” the bank said in a statement.
“The path for the key ECB interest rates will continue to be determined by the Governing Council’s forward guidance and its strategic commitment to stabilize inflation at 2% over the medium term.”
Bond purchases under the ECB’s €1.85 trillion ($2 trillion) Pandemic Emergency Purchase Program (PEPP) ended in March. However, purchases made under the older APP were used as a bridge until the end of the PEPP.
Economists had widely expected the ECB to remain on hold on monetary policy for the time being, setting the stage for action at its June 9 meeting once the uncertain outlook for growth and inflation is in place.
The minutes of the last meeting on March 10 showed that the Governing Council was embroiled in an ambiguous discussion about the pace of monetary policy normalization.
The war in Ukraine and subsequent severe sanctions against Russia, bottlenecks in the supply chain, high energy prices and concerns about a general shortage of raw materials needed for many industrial processes have significantly clouded the economic outlook.
At the same time, inflation rates continue to rise and there are tentative signs that this rise is not just being driven by energy prices but may be systemic in nature.
Anna Stupnytska, global macroeconomist at Fidelity International, said the ECB faces a “tough policy compromise” that is more complex than that faced by other developed-market central banks.
“On the one hand, it is clear that the current policy in Europe, with interest rates in negative territory and still growing balance sheets, is too easy for the high levels of inflation that are becoming more widespread and entrenched,” she said after Thursday’s decision.
“On the other hand, however, the euro zone is facing a huge shock to growth, simultaneously caused by both the war in Ukraine and the impact of the zero-COVID policy on China’s activities. High-frequency data is already pointing to a sharp slump in euro-zone activity in March-April, with worryingly weak consumer-related indicators.”
Fidelity International has a recession in Europe as its base case, although Stupnytska said its severity and duration will depend on how further sanctions against Russia unfold.
“As a full energy embargo becomes more likely, the worst-case recession scenario becomes more likely. We believe that as the growth shock becomes more apparent in next few weeks’ data, the ECB’s focus is likely to shift from high inflation to an attempt to contain economic and market distress as the invasion of Ukraine and its aftermath continue to permeate the system.” , she said.
“Contrary to market prices, we do not expect the ECB to hike rates until the fourth quarter of this year or early 2023.”
Gurpreet Gill, macro strategist at Goldman Sachs Asset Management, said the next milestone in the ECB’s policy normalization agenda will be a decision on the pace of asset purchases in the next quarter, which she says will likely be the focus of the July meeting .
“With market implied pricing already pointing to one rate hike in July and a total of three rate hikes this year, we see limited room for hawkish rhetoric to push prices higher,” Gil added.
Correction: This news has been updated to reflect that the ECB has confirmed it will end asset purchases in the third quarter.
– CNBC’s Annette Weisbach contributed to this report.