FRANKFURT, Feb 3 (Reuters) – The European Central Bank kept policy unchanged as expected on Thursday, staying on track to provide copious stimulus this year even as inflation runs at a record high, exceeding both the bank’s 2% target and its projections.
Having extended support measures only in December, policy change was never seen as an option but stubbornly high inflation – 5.1% last month – is likely to put pressure on policymakers in the months ahead to curb stimulus.
Making only the smallest change to its policy stance, the ECB removed a clause stipulating that its next policy move could be in “either direction”.
“The Governing Council stands ready to adjust all of its instruments, as appropriate, to ensure that inflation stabilises at its 2% target over the medium term,” the ECB said, while maintaining that rates could still be cut, if necessary.
The task of preparing the ground any possible future shift will fall to ECB President Christine Lagarde and markets will be on the lookout for any hints in her 1330 GMT news conference.
She is unlikely to break from the ECB’s long-running view on inflation but could acknowledge that risks are mounting, requiring its attention.
The central bank for the 19 countries that use the euro has long argued that inflation will soon abate without its intervention and actually fall below its 2% target by year-end, so that withdrawing support now would be counterproductive.
But financial investors and a number of policymakers have started to question this narrative, especially since the ECB has persistently underestimated the current spike, forcing it to repeatedly revise its forecasts.
Markets already doubt the ECB projections and are pricing in 28 basis points of rate hikes this year, with the first move seen in July, despite the bank’s insistence that any move in 2022 is very unlikely.
The issue is that inflation is forecast to hold just below its 2% objective in 2023 and 2024, so even a small increase in the inflation path could put price growth right on target, reducing the need for stimulus.
NEW NARRATIVE?
But changing the inflation narrative is a tricky and potentially risky exercise.
If Lagarde admits that the ECB has underestimated price pressures, markets will bring forward rate-hike bets, increasing borrowing costs for governments and businesses even as the ECB seeks to keep these pinned near record lows.
In her news conference, Lagarde could offer a nod to inflation risks while emphasizing that the base case is still for price growth to slow sharply late in the year, as wage growth in the euro zone remains muted and one-off factors fade.
She is also almost certain to repeat that any rate move this year is very unlikely, even as global peers like the U.S. Federal Reserve and the Bank of England tighten policy.
Economists, usually more conservative than financial investors, are nevertheless moving forward their rate hike predictions, with many now expecting a first move in early 2023 rather than late next year.
German 10-year yields, a benchmark for the bloc, are already in positive territory, coming up from levels around -0.4% in late December as the yield curve steepens in anticipation of eventual policy tightening.
Lagarde also cannot fully ignore the inflation overshoot as a string of forecasting errors and big upward revisions to projections challenge the bank’s credibility.
Instead she is likely to emphasize that price growth in Europe is fundamentally different to that in the United States, given weak wage pressures and the relative lag in rebounding consumption.
But with euro zone unemployment also falling to a record low well ahead of the ECB’s projections, wage pressures could also start to build even if there is no evidence for this yet.
With Thursday’s decision, the ECB’s deposit rate remains at a record-low minus 0.5% and the bank is still on course to phase out its 1.85 trillion euro pandemic emergency bond buying scheme by the end of March.
Bond buys will be reduced in several steps over the coming quarters but are still scheduled to run indefinitely.
