ECB cuts stimulus plans as Ukraine war raises inflation expectations

The European Central Bank has scaled back its bond-buying stimulus plan to counter rising inflation caused by the war in Ukraine, while allowing itself more flexibility about the timing of a potential rate hike this year.

“Russia’s invasion of Ukraine is a turning point for Europe,” the ECB said in a statement declare following a meeting of its management board in Frankfurt on Thursday, adding that it would “take whatever action is necessary. . . pursue price stability and protect financial stability”.

Analysts interpret the ECB’s move to speed up its retreat from more bond-buying as a signal that it may raise interest rates in the fourth quarter in an attempt to curb soaring inflation – which will be the driving force the first in more than a decade.

However, the ECB also has more time to wait before raising rates after the bond buying ends. “It’s been a mixed message, although the market has interpreted it as hawkish overall,” said Dirk Schumacher, head of European macro research at Natixis.

Investors have responded by selling euro zone bonds, pushing Germany’s 10-year yield to 0.27%, the highest in more than three weeks. Riskier eurozone debt also took a hit, with Italy’s 10-year yield rising 0.2 percentage points to 1.89 percent. Bond prices fall as yields increase.

Seema Shah, chief strategist at Chief Global Investors, said: “The faster fall in asset purchases will probably come as a surprise to market participants who were expecting ECB speculation when faces weaker growth forecasts,” said Seema Shah, chief strategist at Chief Global Investors.

The euro briefly rallied following the ECB’s announcement, before falling 0.6% to $1.1013 against the US dollar.

Christine Lagarde, president of the ECB, said Russia’s invasion of Ukraine had dealt “a huge shock” to the eurozone economy, adding that the central bank was forecasting higher inflation. and lower growth over the next three years.

Setting out a plan to buy bonds falling faster this year, the ECB said it would reduce asset purchases to 40 billion euros in April, 30 billion euros in May and 20 billion euros in June. they are steadily reducing net buying from 40 billion euros a month in April to 20 billion euros a month since October.

It may stop adding to its existing €4.6 billion bond portfolio in the third quarter “if incoming data support expectations that the medium-term inflation outlook will not weaken even after ends up buying our net assets”.

A separate 1.85 billion euro emergency bond-buying plan launched in response to the coronavirus pandemic will stop the planned net buying at the end of March, it said.

However, the central bank reneged on its pledge to end asset purchases “just before” it raises interest rates, saying instead that any change to the rate would be “gradual” and to “some time” after the property purchase is closed, which Lagarde says can mean months, or a week later.

The war in Ukraine has led some economists to warn about risk of stagnation inflation, where the supply-side inflation shock is combined with stagnant growth. This leaves the ECB in a difficult position, torn between its desire to tackle inflation expected to remain above its 2% target until at least next year and its desire to support the economy.

The ECB cut its growth forecast for this year to 3.7%, down from 4.2%, and Lagarde said high inflation could put further downward pressure on demand. It raised its inflation forecast for this year from 3.2% to 5.1%. But importantly, it predicts inflation will fall to 2.1% next year and 1.9% in 2024 – meaning it has yet to fulfill a key condition for a rate hike.

“Inflation could be significantly higher in the near term,” Lagarde said. “However, under all circumstances, inflation is expected to stabilize around our target in 2024.”

Just last month, the ECB’s governing board agreed that it could accelerate the “gradual normalization” of its ultra-loose monetary policy. But the invasion of Ukraine and sanctions imposed on Russia put the plan in doubt after economists cut their growth forecasts and predicted inflation would rise from record level of 5.8% achieved in February.

Lagarde said the ECB is working with the European Commission to “provide tools and means of support” to Ukraine and its population, including more than 2.1 million people who have fled the country. EU politicians have called for the ECB to open a swap line with Ukraine’s central bank and the banks of other refugee host countries to help them access the euro, but its regulations make it difficult This becomes difficult.

The Eurosystem representation facility that allows the ECB to provide euro-denominated liquidity to central banks outside of the single currency area has also been extended until January 15, 2023.

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