MNI STATE OF PLAY: ECB To Opt For Caution As War Fuels Prices

The European Central Bank is likely to hold off from any move to slow the pace of asset purchases ahead of a possible first interest rate hike this year, as the war in Ukraine raises European and global uncertainty and soaring energy costs threaten to both send price pressures upwards and dampen growth.

March’s meeting of the ECB’s Governing Council had been expected to see monetary policy edging towards normalisation, with February’s headline inflation print of 5.8% coming hot on the heels of January’s 5.1%, and national central bank governors and Executive Board members alike becoming more inclined to tighten.

However, despite rising energy costs fueling broad-based price pressures, raising questions about the likelihood of inflation being in line with the ECB’s 2% target in 2024, the indications are that policymakers will err on the side of caution. Even the Council’s more hawkish members have in recent days questioned whether key interest rates will rise before 2023, with the conflict in Ukraine expected to shave up to 0.4 percentage point off euro area growth this year.

President Christine Lagarde is likely to point to how the conflict has intensified two-way risks to the outlook, and to echo recent comments by central bank governors who stressed the need to maintain maximum policy flexibility and optionality.

FORWARD GUIDANCE

That could mean that the ECB will stick to its current forward guidance on the pace of asset purchases - set at EUR40 billion per month for Q2 - and the sequencing of policy steps for the time being, without making any promises as to future policy moves.

Equally, Lagarde will reiterate that the Governing Council is prepared to use all the tools at its disposal - including a reactivated, or possibly re-named Pandemic Emergency Purchase Programme - to achieve its medium-term price stability objective and prevent market fragmentation.

Chief economist Philip Lane said last week that the cut-off point for March’s Eurosystem staff growth and economic projections - which are expected to show a further uptick in harmonised and core inflation - has been extended to include the latest data, amid talk of a wage-price spiral in Germany and as sources told MNI that the Governing Council sources had switched to “emergency mode.”

Remaining to be seen are any measures the ECB is willing and able to take to enforce EU sanctions against Russia, the extent which it will provide additional liquidity in response to the crisis, and whether the Governing Council discussed extending or expanding its existing instruments, such as the Asset Purchase Programme, or creating new ones, to mitigate the effects of increased uncertainty caused by the war.

The president may also face questions as to how the ECB can effectively counter the threat of stagflation and as to its approach to any new EU bond issuance aimed at bolstering the EU’s defense capabilities while reducing its reliance on Russian gas and oil.