MNI SOURCES:ECB To Hold Course For Tightening Amid Uncertainty

The European Central Bank will reaffirm its commitment to removing pandemic stimulus at its meeting next week, moving towards phasing out bond purchases ahead of possible rate rises from September this year, but it will also stress its ability to change course if necessary at a time of extreme uncertainty, Eurosystem sources told MNI.

An end to net bond purchases and the return of the deposit rate to around zero from the current -0.5% would normalise monetary policy in response to a spike in inflation, without, officials calculate, tightening financial conditions across the eurozone. The ECB could next Thursday say it will conclude its Asset Purchase Programme by as soon as June, opening the way to a possible hike in September, but officials note that many things could go wrong, as war rages in Ukraine, the Covid pandemic lingers, and France faces a possible presidential run-off vote featuring a far-right candidate with an outside chance of victory.

“I certainly think September is 'live', as they say, particularly being a projection round month as well. That certainly isn't saying it will happen, but it’s very much a possibility,” one official said. “And if we move in September, we could be at zero by Christmas. I personally think moves will be in 25s and not a case of straight to zero on the first hike -- but again, we really don't know where we will be in six months.”

FRENCH ELECTION ADDS TO UNCERTAINTY

Asked about the multiple sources of uncertainty, the official said it was too early for the ECB to factor in possible complications from the French election, at a time when its next macroeconomic projections due in June are already set to show a significant downgrade in growth prospects even as an energy squeeze sends inflation soaring. The Federal Reserve is also signalling an aggressive tightening cycle, prompting concern over euro depreciation. (see MNI INTERVIEW: ECB Should Guard Against Euro Weakening-Knot)

“This is why the change in language has helped with flexibility,” the official said, referring to the ECB’s current commitment to adjusting rates “some time” after the end to net asset purchases. “We can end APP in June, July, that opens us up for a rate hike in September, but we have the option of delaying if we need to -- it is not mechanical.”

It is possible that the ECB’s medium-term forecast, which pointed to inflation at 1.9% when it was last updated in March, could rise to 2% in the next projections in June, the source said. This would be a key level which even doves accept would indicate the ECB should move to raising rates.

“There is certainly a possibility it will be. But then hypothetically, in this highly unpredictable time, it may even be back below 2% by the time of the September meeting,” the official cautioned.

SECOND-ROUND EFFECTS

Meanwhile, price trends are beginning to rattle the confidence even of some of the ECB’s more dovish officials.

“I am a bit more worried about wages from what I was before,” a source from a national central bank which has tended to favour stimulus told MNI. “We are getting to a point where price increases are everywhere and the public is not only seeing it …. but feeling it and suffering it. Sometimes you can say that there is a tipping point after which it is very difficult to return.”

But this official remained cautious about whether the ECB would end APP in the third quarter. While ECB officials generally doubt that bond purchases at levels such as the EUR20 billion scheduled for the month of June have much stimulus effect in themselves, reducing them to zero would send the signal that rate rises were coming next.

“We are talking about keeping optionality open,” the official said. “We face a dilemma: choosing between choking a recovery or letting inflation run … but in my view the key won’t be in buying some billions more or some billions less.”

One effect of the war could be to further entrench inflation in the eurozone economy, another Eurosystem source said. While it was still too early to say how many interest rate hikes it would be reasonable to expect this year, the official stressed that rate hikes should not be long in coming.

“Unless there is a dramatic change, then I think this “some time” should not mean a very long time,” he said, referring to the ECB’s current guidance, and adding the eurozone economy should be strong enough to avoid stagflation.

“From minus point five to zero will not be I think felt so much, even by borrowers, so I think we can move with more confidence when we're getting out of negative rates,” he said, “But even then, still, interest rates will remain very low.”

An ECB spokesperson declined to comment on the matters in this article when contacted by MNI.