ECB poised to normalize monetary policy

Frankfurt, Germany | Xinhua | The European Central Bank (ECB) unveiled on Thursday a roadmap to wind down stimulus policies and possibly raise interest rates later in 2022.

The decision to taper and possibly reverse a years-long policy of negative interest rates came at a time when inflation in the euro area hit a new record high and economic recovery is threatened by stagflation.

READY TO TIGHTEN

The statement made by the ECB after its governing council meeting sent a hawkish signal. ECB President Christine Lagarde unveiled that the central bank will probably conclude net purchases under its asset purchase program (APP) in the third quarter, opening the door to raise interest rates.

“If the incoming data support the expectation that the medium-term inflation outlook will not weaken even after the end of our net asset purchases, the Governing Council will conclude net purchases under the APP in the third quarter,” Lagarde said.

“Any adjustments to the key ECB interest rates will take place some time after the end of our net purchases under the APP and will be gradual.”

Although Lagarde also cautioned that the plan to end the APP should be subjected to changes, the APP phaseout schedule opened the possibility that interest rate hikes can happen in 2022, a reversal of Lagarde’s estimation in November 2021 that it was highly unlikely for the ECB to raise interest rates.

Meanwhile, the central bank confirmed its previous plan that the pandemic emergency purchase program will come to an end in March as planned.

It also dropped dovish assertions such as interest rates could be lowered, a sign that the ECB stands ready to accelerate its pace of tapering.

WARY OF RISKS

The ECB has been consistent in its assessment about the economy and inflation.

Inflation in the euro area soared to a record high of 5.8 percent in February, mainly on the back of surging energy prices.

Lagarde said that the ECB has revised up its projection of the euro area inflation. The ECB staff foresee that inflation will be 5.1 percent in 2022, 2.1 percent in 2023 and 1.9 percent in 2024.

She warned that inflation can be considerably higher in the near term due to the economic and financial impact of the Russia-Ukraine conflict.

Economic activity “could be dampened significantly by a steeper rise in energy and commodity prices and a more severe drag on trade and sentiment,” Lagarde said.

The ECB also lowered its forecast of the GDP growth in the euro area to 3.7 percent in 2022.

In spite of the short-term negative impact, the euro area economy, according to Lagarde, is still helped by “ample policy support” and the underlying conditions are “solid.”

Having its eyes on the medium term target of around 2 percent, the ECB insists that the inflation is expected to hit its target in 2024 “in all scenarios.”

HAUNTED BY STAGFLATION

The ECB decision on Thursday came as a surprise to some market observers who had speculated that the central bank might extend its asset purchase program to prop up the economy.

There used to be widespread hopes that the inflation, which was largely attributed to supply chain bottlenecks and imbalance of supply and demand, could be short-lived. However, inflation turned out to be stubborn and part of it became entrenched as it translated into higher wage, food and commodity prices.

Lagarde pointed out that most measures of underlying inflation had risen and it is uncertain how persistent the rise in the indicators would be.

In general, tightening measures can lift the real interest rate and help bring down inflation while pushing up borrowing costs for individuals, companies and governments. Higher interest rates could also hurt consumption and economic recovery, warned some analysts.

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Xinhua