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Omicron casts further doubt on ECB’s commitment to further stimulus measures

European Central Bank policymakers are reassessing the extent of their commitment to additional stimulus measures, reflecting growing doubts about inflation is expected to slow down. how quickly the coronavirus variant Omicron caused price concerns to continue to rise.

The trio of recent events have sown doubt in the minds of some valuators at the ECB, who have forecast for months that inflation will fall back below target and justify the continuation of policies. vast stimulus.

The first was that eurozone inflation spiked to 4.9% in November, well above the ECB’s 2% target and a record since the euro was created two decades ago. Followed by the appearance of a new coronavirus variant, which threaten to prolong the pandemic and with it the bottlenecks of the supply chain that have pushed prices up.

Then last weekend, the US Federal Reserve said it would hurry the end of its bond-buying program to tackle inflation, putting pressure on the ECB to rein in its own asset-buying plans.

Ahead of next week’s ECB meeting, analysts fear that the events together increase the likelihood of a “hawkish” shift by rate-setters to withdraw stimulus measures sooner than economists do. investment expectations, increasing the odds of a sell-off in eurozone government bonds. market.

An ECB governing board member said: “Regarding Omicron, it is clear that it will hold inflation for longer as supply chain disruptions will last longer.

“The pandemic has changed the structure of the economy, with more housework, higher carbon prices and a shift away from globalization,” continued the council member. “Over the medium term, inflation could be well above our target and then we’ll have to act.”

Line chart of the harmonized consumer price index (% change year-on-year) shows euro zone inflation set a new record

The central bank is expected to announce at its meeting next Thursday that it will stop buying new bonds in March under a 1.85 billion euro emergency program launched in response to the pandemic. But ECB policymakers could also delay a further decision on how many more bonds they will buy in 2022 until early next year.

A second board member said: “I would be very uncomfortable committing to anything after the end of the second quarter of next year. “The market will have to live with that.”

A third board member said delaying their decision on future bond purchases was possible “depending on the pandemic and new data over the next two weeks”.

The ECB has bought more than €2.1 billion in bonds over the past two years, more than total net issuance by eurozone governments in an effort to keep borrowing costs low.

But analysts at UniCredit calculate that this could change next year, although eurozone governments are expected to raise less debt, unless the central bank doubles the amount. bonds they purchased under the previous asset purchase program to 40 billion euros a month from April until its end. of the year 2022.

By continuing to buy large-scale bonds next year, the ECB will be a significant exception from other central banks that plan to stop buying assets soon, including the Fed and the Bank of England. Bank of Canada has done so.

The ECB council is increasingly consensual that there is little benefit from increased monthly asset purchases in inflation-promoting conditions, according to two of its members. One said: “There is no reason to extend the asset purchase program beyond March.

Analysts say the ECB may commit to another “envelope” of bond purchases after March next year. But they said their decision was complicated by the fact that it would almost certainly raise their 2022 inflation forecast above 2% next week, making it a justification for a commitment to continue to buy large amounts of bonds. becomes more difficult.

Frederik Ducrozet, strategist at Pictet Wealth Management, said: “The opposite surprises are sizable in terms of inflation and the ECB’s revised 2022 forecast will be one of the highest ever. in the history of these projections”. He expects the central bank to raise its inflation forecast for next year from 1.7% to 2.7%.

Reinhard Cluse, economist at UBS, said: “The upcoming meeting is likely to be one of the toughest for the board in recent times, given the opposite pressure on the mandate. its inflation.” Government bonds in southern Europe’s periphery, he added, “seem vulnerable to the change in ECB communication”.

Christine Lagarde, president of the ECB, said last week that the bank was “very difficult” increase its deposit interest from negative 0.5% next year, because it still expects inflation to fall below target in 2023.

Despite Lagarde’s comments, markets are still pricing the ECB up 0.1 percentage point by the end of next year, although a month earlier investors had bet on two rate hikes in 2022. .

“They worked on that message a lot and it finally got through,” said Antoine Bouvet, assessment strategist at ING. “Part of the reason things have been so difficult is because of the Fed, whose influence has leaked through the pricing of eurozone interest rates.”

The ECB has pledged not to raise interest rates until it stops buying assets, something economists say is unlikely before 2023, even as it continues to reinvest the proceeds from mature bonds. long after that. “They could end up buying assets in mid-2023 and then could see their first rate hike at the end of 2023,” said Katharina Utermöhl, economist at Allianz.

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