The European Central Bank faces a difficult balancing act, with inflation hitting record levels, while 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 its policy meeting next month and lowered its growth forecast.
In the wake of the latest monetary policy meeting, the Board of Governors announced that it intends to raise key interest rates by 25 basis points at its July meeting.
The European Central Bank expects a further rise at its September meeting, but said the size of that increase will depend on the evolving trajectory of its medium-term inflation outlook.
At the moment, interest rates on the main refinancing operations, marginal lending facilities and deposit facilities remain unchanged at 0.00%, 0.25% and -0.50%, respectively.
“After September, based on its current assessment, the Governing Council expects that a gradual and sustained path of further rate increases will be appropriate,” the ECB said in a statement on Thursday.
“In line with the Board’s commitment to the 2% medium-term target, how quickly the Board adjusts its monetary policy will depend on incoming data and how inflation assesses medium-term development.”
Annual consumer price inflation in the 19-country eurozone Set a new record high of 8.1% in MayHowever, the European Central Bank in its previous guidance indicated that the first rate hike would not come until after the official end of its net asset purchases on July 1.
Markets have been eagerly awaiting the meeting in Amsterdam on Thursday, the first of the Board of Governors outside Frankfurt since the onset of the coronavirus pandemic, for indications of how aggressive the shift in interest rates will be in the coming months.
Policymakers face the challenge of curbing inflation without compounding the economic slowdown caused by the war in Ukraine and associated sanctions and embargoes between the European Union and Russia, which were previously a major source of energy imports for the bloc.
Economists have been torn over whether they want it Expect a rise of 25 basis points or 50 basis points In the July and September meetings, the European Central Bank is widely expected to exit negative interest rate territory by the end of September from its historic low of -0.5%.
Slowing growth and high inflation
The European Central Bank also lowered its growth forecast and revised upward its inflation forecast. Annual inflation is now expected to reach 6.8% in 2022, dropping to 3.5% in 2023 and 2.1% in 2024. This is a significant increase from March’s forecast of 5.1% in 2022 and 2.1% in 2023 and 1.9% in 2024.
Growth forecasts were revised higher to 2.8% in 2022 and 2.1% in 2023, and revised upwards slightly to 2.1% in 2024. This compares with expectations at the ECB’s March meeting of 3.7% in 2022 and 2.8% in 2023 and 1.6% in 2024.
The board also said it is ready to adjust all its policy tools to ensure inflation is stable towards the 2% target over the medium term.
“The pandemic has shown that, under difficult circumstances, flexibility in the design and implementation of asset purchases has helped in the face of poor monetary policy transmission and made the board’s efforts to achieve its objective more effective,” a statement on Thursday said.
“Within the ECB’s mandate, and under tense conditions, flexibility will remain an element of monetary policy when threats to monetary policy transmission threaten price stability.”
Randall Kruszner, a University of Chicago economics professor and former governor of the Federal Reserve System, told CNBC before Thursday’s meeting that it was “very important” for the European Central Bank to start acting on interest rates.
The US Federal Reserve It began raising rates in March and carried out a 50 basis point hike in May, its biggest rise in 22 years, as the FOMC meeting minutes pointed to more strong hikes ahead. The Bank of England It raised interest rates in four consecutive meetings to raise the policy rate to its highest level in 13 years.
“Inflation is very high, and it will likely become entrenched unless it does [ECB policymakers] Move in, and they’re moving hard and making it clear that they’re going to go further,” Krossner told CNBC’s “Squawk Box Europe” on Thursday.
“They risk inflation becoming entrenched, inflation expectations becoming unchecked, and being forced to raise rates much higher than they would otherwise have to.”
Nevertheless, Kreuzner sympathized with the difficult situation in which the Governing Council finds itself, given the closeness of Europe to the war in Ukraine, interdependence with Russia, and therefore the state of economic danger.
“Their concern is that there are a lot of negative shocks from war, sanctions and uncertainty, and that the economy will slow even without raising interest rates, so inflationary pressures will fade,” he said.
“But there is enough inflationary pressure and enough risk that inflation expectations will become unproven, and that they really have to act.”
Continued upside surprises in European inflation and evidence of its persistence, combined with the Federal Reserve’s aggressive tightening trajectory, have been pressing the ECB to “normalize policy,” said Anna Stupnitska, global economist at Fidelity International.
“While the risk of declining long-term inflation expectations does not appear to be high, the rapid expansion of policy differentials versus the Fed presents challenges for the ECB, with EURUSD re-pricing in the spotlight,” she said.
“But arguably doing too much too soon would be a riskier strategy for the ECB given the weak growth background as well as the risk of fragmentation of the peripheral spread.”
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