MNI: ECB Can’t Rule Out Faster Normalization-IMF

The ECB should continue “gradual normalization” of its balance sheet and interest rates and be prepared to move faster if inflation expectations shift higher while monitoring the danger of a fragmentation in monetary conditions within the eurozone, the IMF said Friday.

Wrapping up net asset purchases in the third quarter in line with ECB guidance is appropriate and subsequent rate hikes must be tied to inflation and other data, the fund’s Regional Economic Outlook said.

“Faster normalization cannot be ruled out, should inflation continue to surprise to the upside and wage pressures build,” the IMF said. But it added: “Inflation expectations, while drifting upward, remain anchored around the target. In addition, the handover from public to private demand is far from complete.”

The ECB will also “need to carefully manage the reduction of asset purchases to avoid cliff effects and watch out for fragmentation in financial conditions in the event downside risks materialize," the IMF said. Work by the European Central Bank on a new tool to cap any blow-out in bond spreads is still at a preliminary stage, Eurosystem sources told MNI.

The IMF has cut this year’s GDP growth forecast in advanced European economies by 1pp to 3%, citing the Ukraine war and lingering Covid cases, and said some of the lost output will be permanent. The inflation forecast was boosted 2.2pp to 5.5%.

“With inflation running far above targets, monetary policy should maintain the course to normalization,” across Europe, the IMF said. “Importantly, policymakers should head off the emergence of wage-price spirals.”

The UK should also continue normalizing policy "given its historically tight labor markets," the IMF said.