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Thursday, May 26, 2022

The ECB leaves the eurozone reference interest rate at zero percent

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Dhe European Central Bank (ECB) keeps the key interest rate unchanged and continues to buy bonds for the time being. This was announced on Thursday by the Governing Council of the ECB, the highest monetary policy body of the central bank. The PEPP crisis program bond purchases are scheduled to expire at the end of March. The so-called deposit rate remains at minus 0.5 percent, so banks must continue to pay negative interest on their deposits with the central bank.

“If incoming data supports the expectation that the medium-term inflation outlook will not weaken even after our net asset purchases end, the Governing Council will end net purchases under the APP in the third quarter,” the Governing Council wrote. central bank.

As for possible increases in interest rates, the Council continues to be reluctant to make a pronouncement. “Any adjustment to key ECB interest rates will take place some time after the end of Governing Council net purchases under the APP and will be phased in gradually,” he said. The Council stressed the flexibility with which it is important to proceed in the face of the new uncertainty caused by the war in Ukraine. The president of the ECB, Christine Lagarde, will explain the details in the subsequent press conference.

Evidently, the ECB is proceeding cautiously in the face of new imponderables for the eurozone economy. However, it does not seem to be fundamentally suspending the planned normalization of monetary policy.

Interest rate expectations had fallen with the war.

At the previous ECB Council meeting in early February, Lagarde caused a stir because, when asked, she no longer wanted to rule out that key interest rates could rise this year. This had caused interest rate expectations in financial markets to rise significantly. Commerzbank chief economist Jörg Krämer even expected that the central bank will now abolish negative interest rates in two steps this year. However, since the attack on Ukraine, expectations of interest rate increases have diminished. Christian Keller, the chief economist at Barclays Bank, now expects no more rate hikes this year. However, ECB observers’ assessments differ on this issue.

The central bank faces a big challenge: on the one hand, inflation has risen sharply. This has also forced the central bank to revise its inflation forecasts. On the other hand, the war in Ukraine has caused a new uncertainty, also with regard to economic development.

Now there is the terrible war. And with it the concern that the euro zone economy could be exposed to more serious disruptions. This could mean “stagflation”: very weak economic development combined with high inflation due to the energy price shock. “The individual representatives of the Governing Council of the ECB no longer wanted to rule out a stagflation scenario for the euro zone,” says Christian Reicherter, an analyst at DZ Bank: “We believe that it is quite likely that these fears in view of the current situation and the coming quarters come true.”

“That is the biggest risk: that we have the same experiences as in the 1970s,” ECB Chief Economist Otmar Issing told the Bloomberg news agency. Stagflation is “the worst combination for a central bank.” He recommended that members of the ECB’s Governing Council focus on containing inflation and begin to reduce asset purchases.

Economist Fratzscher expects inflation of up to 10 percent

In February, the inflation rate in the euro area was already 5.8 percent. Due to delays in data collection, this does not even include the sharp increase in energy prices following Russia’s attack on Ukraine. Consequently, inflation is likely to rise further. The director of the Ifo Institute in Munich, Clemens Fuest, said Thursday on Bavarian radio that if Russian gas supplies were stopped, “prices would rise again very sharply.” So it could be “significantly more” than five percent.

The president of the German Institute for Economic Research (DIW), Marcel Fratzscher, went a step further when it came to inflation and warned of inflation of up to ten percent as a result of the war. “There will probably be inflation rates of more than five percent in the current year,” he told the “Neue Osnabrücker Zeitung.” “In case of an escalation of the war and more and more new sanctions, it can even go up to 10 percent.”

In any case, the new situation means more uncertainty, which is why members of the ECB Council, such as the president of the French central bank, François Villeroy de Galhau, advocated greater “optionality”, that is, the ECB should have more margin to react flexibly to the possible consequences of war and to be able to react to the shock of energy prices. Apparently this also found support from other council members. Flexibility is the “need of the hour,” said chief economist Fritzi Köhler-Geib at development bank KfW. Greek central bank chief Yannis Stournaras, on the other hand, had publicly advocated staying the old course for the time being and buying more bonds at least until the end of the year.


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