The European Central Bank faces a difficult balancing act, with inflation hitting record levels as the war in Ukraine casts a shadow over growth prospects.
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The European Central Bank on Thursday confirmed its intention to raise interest rates at next month’s monetary policy meeting and downgraded its growth forecasts.
Following the last monetary policy meeting, the Governing Council announced that it intends to raise key interest rates by 25 basis points at the July meeting.
The ECB expects a further increase at its September meeting, but said the scale of this increase will depend on the evolution of the path of the medium-term inflation outlook.
For now, the interest rates on the main refinancing operations, marginal lending facility and permanent deposit facility remain unchanged at 0.00%, 0.25% and -0.50%, respectively.
“After September, based on its current assessment, the Governing Council anticipates that a gradual but sustained path of further interest rate hikes will be appropriate,” the ECB said in a statement on Thursday.
“In line with the Governing Council’s commitment to its medium-term target of 2%, the pace at which the Governing Council adjusts its monetary policy will depend on the data it receives and how it assesses inflation developments over the medium term.”
Annual consumer price inflation in the 19 euro area members hit a new high of 8.1% in May, but the ECB in its previous guidance indicated that a first rate hike would only come after the formal end of its net purchases. of assets on July 1 .
Markets were eagerly awaiting Thursday’s Amsterdam meeting, the first of the Governing Council outside Frankfurt, Germany, since the start of the coronavirus pandemic, for signs of how aggressive the change in interest rates will have to be in the coming months. months.
Policymakers face the challenge of containing inflation without exacerbating the economic slowdown resulting from the war in Ukraine and the associated sanctions and embargoes imposed between the European Union and Russia, previously a major source of energy imports for the bloc.
Economists are divided on whether to expect 25 basis point or 50 basis point hikes at the July and September meetings, with the ECB widely expected to exit negative rate territory by the end of September from its current all-time low of -0, 5%. .
The euro initially retreated after the decision, before rebounding to a 0.5% gain against the dollar in mid-afternoon.
Slower growth, higher inflation
The ECB also lowered its growth forecasts and revised upwards its inflation forecasts. Annual inflation is now expected to reach 6.8% in 2022, falling to 3.5% in 2023 and 2.1% in 2024. This marks a substantial increase from the March projections of 5.1% in 2022. , 2.1% in 2023 and 1.9% in 2024.
Growth forecasts were revised down significantly to 2.8% in 2022 and 2.1% in 2023, and slightly revised down to 2.1% in 2024. This compares with the ECB’s March meeting projections of 3.7 % in 2022, 2.8% in 2023 and 1.6% in 2024.
The Governing Council also said it is ready to adjust all its policy instruments to ensure that inflation stabilizes towards its 2% target over the medium term.
“The pandemic has shown that, under stress conditions, flexibility in the design and conduct of asset purchases has helped to combat the impaired transmission of monetary policy and made the Governing Council’s efforts to achieve its objective more effective,” the statement said. from Thursday.
“Within the ECB’s mandate, under stress conditions, flexibility will remain an element of monetary policy whenever threats to the transmission of monetary policy jeopardize the achievement of price stability.”
Randall Kroszner, an economics professor at the University of Chicago and former governor of the Federal Reserve System, told CNBC ahead of Thursday’s meeting that it was “very important” for the ECB to start tinkering with interest rates.
The US Federal Reserve began raising rates in March and implemented a 50 basis point hike in May, the biggest in 22 years, with Federal Open Market Committee meeting minutes pointing to more aggressive hikes ahead. The Bank of England raised rates at four consecutive meetings to bring the benchmark interest rate to a 13-year high.
“Inflation is very high, it has the potential to consolidate unless [ECB policymakers] they move, and they move aggressively and make it clear that they’re going to move forward,” Kroszner told CNBC’s “Squawk Box Europe” on Thursday.
“They run the risk of inflation getting entrenched, inflation expectations becoming unanchored and having to raise rates much more than they would have to.”
However, Kroszner expressed empathy with the difficult position the Governing Council finds itself in, given Europe’s proximity to the war in Ukraine, interdependence with Russia and therefore the state of economic peril.
“The concern they have is that there are so many negative shocks coming from the war, sanctions, uncertainty, that the economy is going to slow down even without raising rates, so inflationary pressures are going to ease,” he said.
“But there’s enough inflationary pressure and enough risk that inflation expectations become unanchored that they really need to move.”
Anna Stupnytska, global macroeconomist at Fidelity International, said continued upward surprises in European inflation and evidence of their persistence, along with the Fed’s aggressive tightening path, are putting pressure on the ECB to “advance” policy normalization.
“While the risk of de-anchoring in long-term inflation expectations does not seem high, the rapid widening of policy spreads vis-a-vis the Fed presents challenges for the ECB, with the EURUSD revaluation in the spotlight,” she said.
“But doing too much too soon would arguably be a riskier strategy for the ECB in light of a weakened growth scenario as well as the risk of peripheral spread fragmentation.”