ECB scales back stimulus despite Ukraine war uncertainty

Governor Christine Lagarde says central bank is in no rush to raise interest rates

Christine Lagarde says the ECB will not raise interest rates until some time after it has ended its bond buying at the end of the third quarter. AFP
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The European Central Bank left its key interest rates unchanged on Thursday and unveiled a faster winding down of its asset purchase programme than expected as soaring inflation outweighed concerns around Ukraine war.

With inflation in the eurozone already at a record high of 5.8 per cent in February, and the potential for an even higher reading this month, the central bank was under pressure to act to keep prices in line with its 2 per cent target.

Calling Ukraine war a “watershed” moment for Europe, the bank pledged to slow bond buying from the start of May, and said it could halt the programme as soon as the third quarter.

“The Governing Council expresses its full support to the people of Ukraine. It will ensure smooth liquidity conditions and implement the sanctions decided by the European Union and European governments,” the ECB said.

“The Governing Council will take whatever action is needed to fulfil the ECB’s mandate to pursue price stability and to safeguard financial stability.”

The hawkish move came as a surprise for investors who had expected the ECB to keep its options open until there is more clarity about the war, the impact of sanctions and the future course of commodity prices.

In Thursday's decision, the bank confirmed plans to wrap up its €1.85 trillion ($2.04tn) Pandemic Emergency Purchase Programme at the end of the month and said purchases under the older Asset Purchase Programme (APP) will be smaller than previously planned.

It now expects APP purchases to total €40 billion in April, €30bn in May and €20bn in June. Previously it set purchases at €40bn in the second quarter, €30bn in the third quarter and €20bn in the fourth quarter.

“The ECB’s monetary policy statement signalled it is more concerned about a further sharp rise in inflation than the negative shock to demand which will result from the war in Ukraine,” said Paul Dales, chief UK economist at Capital Economics.

“Far from delaying its planned policy tightening, the Bank has accelerated the pace of its taper and may end net purchases completely in Q3. This would pave the way for rate hikes in the second half of the year.”

While the central bank opted to leave its main refinancing rate at 0 per cent, and its deposit facility rate remained at 0.5pc, the bank said it plans to increase interest rates “some time” after the end of net asset purchases rather than “shortly after”.

ECB President Christine Lagarde said the ECB had no intention of raising interest rates until some time after it has ended its bond buying at the end of the third quarter.

“Any adjustment to the key ECB interest rates will take place some time after the end of our net purchases under the APP [Asset Purchase Programme] and will be gradual,” Ms Lagarde said.

“The path for the key ECB interest rates continues to be determined by the Governing Council's forward guidance and by its strategic commitment to stabilise inflation at 2 per cent over the medium term.”

The euro gained ground against the dollar following the announcement, briefly topping $1.1100 before easing back.

Markets now see around 43 basis points' worth of interest rate hikes this year, up from around 30 basis points predicted before the meeting.

“All in all, today’s decisions are a good compromise, keeping maximum flexibility in a very gradual normalisation of monetary policy,” said ING economist Carsten Brzeski.

“A first rate hike before the end of the year is still possible.”

Although the ECB's move came as a surprise, policy normalisation was still seen as unavoidable.

Inflation across the 19 countries that use the euro could be three times the ECB's 2 per cent target this year and is likely to remain elevated next year, too.

A rebound in economic growth and the tightest labour market in decades are also pushing the ECB to abandon its ultra-easy policy stance and end a near decade-long experiment with unconventional stimulus.

Updated: March 11, 2022, 4:03 AM