Since the sudden rise in inflation in the euro area last year, the European Central Bank has been in a dilemma between managing inflation and worrying about the impact of the epidemic on the economy when formulating monetary policy.
In its december interest rate decision, the ECB left the three key interest rates unchanged and closed on the bond-buying program, announcing that 2022Q1 will implement the Emergency Anti-Epidemic Bond Purchase Program (PEPP) at a lower rate than 2021Q4, and the PEPP will last at least until March this year; but at the same time announced that 2022Q2 will increase the bond-buying rate of the conventional asset purchase program (APP) from 20 billion euros per month to 40 billion euros. This continues the ECB's usual cautious tone and reflects its desire to ensure a gradual "smooth landing" of ultra-loose monetary policy during the pandemic.
The minutes of the ECB's December meeting, just released tonight, continue to maintain that tone. The European Council believes that progress in Europe's economic recovery and achieving the medium-term inflation target is sufficient to support the ECB's gradual reduction in asset purchases in the coming quarters, the minutes said. But monetary easing is still needed for inflation to stabilize at the 2% inflation target over the medium term. Given the current uncertainties, the Council needs to remain flexible and selective in implementing monetary policy.
After the minutes were announced, the euro edged higher against the dollar, and the yield on the 10-year German bund did not change much.
Inflation remains high, and there is disagreement within the ECB over the "inflationary theory"
For inflation, the minutes said that the possibility of inflation being high over a longer period of time cannot be ruled out, with inflation in baseline forecasts already relatively close to 2% in 2023 and 2024, and inflation could easily exceed 2% given the forecasted upside risk.
At present, high inflation has become an increasingly difficult situation to ignore in the euro area. The latest data released by Eurostat today confirmed that the eurozone's consumer price index (CPI) final value rose 5.0% year-on-year in December, in line with expectations and initial values, up from 4.9% in November and the highest since 1991. A year ago, the figure was just -0.3 percent. Among them, the largest contribution to inflation was in the energy sector, where energy spending increased by 2.46 percentage points year-on-year, while spending on higher-priced services increased by 1.02 percentage points year-on-year. Prices of non-energy industrial products rose by 0.78 percentage points year-on-year, and food, alcohol and tobacco also rose by 0.71 percentage points.
Data released earlier by the German Federal Statistical Office showed that inflation rose to 3.1 percent for the full year of 2021, the highest level since 1993. The report of the German Federal Statistical Office pointed out that the sharp rise in energy prices, supply bottlenecks and the elimination of VAT preferential policies were the main reasons for the increase in inflation rate in Germany. Data released on Wednesday (January 19) also showed that the final CPI in Germany for December 2021 rose by 0.5% month-on-month, in line with expectations. After the data was released, the yield on the German 10-year bond turned positive for the first time since May 2019.
In a Survey of Economists conducted by Reuters on January 11-18, economists surveyed raised the eurozone's inflation forecast for the first and second quarters of this year by 0.6 percentage points to 4.1% and 3.7%, respectively, compared with the previous survey, both significantly exceeding the ECB's inflation target of 2%. More than two-thirds of economists also expect the Opmecreon strain to have less impact on the European economy than the delta strains that preceded it.
Despite growing inflationary pressures, the ECB has tended to convey to markets that inflation is only temporary. The ECB had previously forecast inflation in the eurozone to be 3.2% for the full year 2022 and slow to 1.8% in 2023 and 2024. In a press conference after the ECB interest rate meeting last December, ECB President Christine Lagarde admitted that eurozone inflation will continue to rise in the short term, above 2% for most of 2022, and the inflation outlook may face upward risks, of which 2/3 of the expected increase in the Harmonized Consumer Price Index (HICP) is due to a sharp rise in energy prices. But she believes energy prices will stabilize this year and long-term inflation is expected to be closer to 2 percent.
However, there is also disagreement within the ECB on the "inflationary theory". Central bank governors in Germany, Portugal and other countries have recently publicly warned that inflation could exceed the ECB's expectations. The governor of Belgium also said the ECB risked underestimating the threat of inflation and lagging far behind its global counterparts in dealing with soaring prices.
The ECB has emphasized policy flexibility, with markets betting on the possibility of interest rate hikes within the year
As for the prospect of interest rate hikes, the minutes show that the council believes that eurozone members generally believe that a lot of monetary policy support is still needed, expressed concern about premature tightening of policies, and believes that it may be premature to announce the end of emergency measures.
Earlier today, ECB President Christine Lagarde also said in an interview with France's International Radio and Television that the situation in Europe is different from that of the United States, inflation in the euro area is "significantly weaker", and the economic recovery is not as fast as in the United States, and the ECB "has every reason" not to act as quickly as the Fed on soaring inflation.
Pablo Hernandez de Cos, a member of the ECB's Governing Council, similarly said in an interview with Spanish television earlier today that no rate hike is expected in 2022 based on current conditions and inflation expectations.
Although the ECB 's "doves" continue, recently, some analysts have begun to suggest that the risk of a sudden policy shift by the ECB, which has been "dovishing", cannot be ignored.
Zhou Hao, senior economist at Deutsche Baerbank Emerging Markets, recently said that the Fed's several interest rate hikes are not the biggest problem, the biggest problem is the European Central Bank. The market's expectations for the Fed's interest rate hikes are sufficient, but the EXPECTATIONS for the ECB's monetary policy are not clear. At present, the mainstream view is that although Europe faces the problem of high inflation, the ECB will not do anything for the time being. However, if the ECB raises interest rates earlier this year or even earlier, it will have a very serious psychological impact on the market.
In fact, the words "flexibility" appeared several times in the December minutes when describing monetary policy. Martins Kazaks, president of the European Central Bank's Governing Council and governor of the Central Bank of Latvia, has also recently stated that the ECB is ready to act if the inflation outlook strengthens, which is indisputable, "do not mistakenly think that we will not raise interest rates, or if necessary we will not cut monetary policy support, flexibility is the most important"
Bank of France Governor Francois Villeroy de Galhau also said on the 19th: "The ECB will do its best to bring inflation back to the level of 2%. If inflation is more persistent than we expected, there is no doubt that we will have the determination and ability to adjust our monetary policy quickly. He also said that France's economy has grown well and is less affected by the Aumechjong strain.
In the above interview, Lagarde also mentioned: "Of course, if the data and facts require it, we are always ready to respond with monetary policy." ”
In fact, markets have also begun to factor in the possibility of a sudden policy shift by the ECB. On Monday, money markets bet that the ECB would tighten policy and raise interest rates by 10 basis points as early as September this year, the first time since the emergence of the Omiljung strain and the impact on the market, investors have bet that the ECB will raise interest rates this year. Subsequently, investors began to bet that the ECB would raise interest rates by 10 basis points by October and another 10 basis points in February and March 2023.
"Zero interest rates and negative interest rates should be purely emergency measures. At present, inflation is above target, inflation risks are skewed upwards, labor markets are tight, and the output gap is narrowing, there is no reason to maintain such low interest rates. Jörg Angeleé, a senior economist at Bantleon Bank, said that "the ECB would do well to start small steps early on to reverse its ultra-loose monetary policy." If it waits too long before acting, the ECB could be forced to hit the brakes a little later, eventually leading to a recession. ”
"It's hard to see a renewed belief in inflation in the short term that inflation is temporary, because the data for the coming months will still be grim." Sandra Holdsworth, head of interest rates at Aegon Asset Management, said: "The market will be nervous before the ECB meeting in March, because of fears that the ECB will change policy and may even accelerate the pace of decoding like the Fed." ”
Kamakshya Trivedi, co-head of global FX and emerging market macro strategy at Goldman Sachs, said: "Once the market reprices the Fed curve, it will also tend to do this to other central banks, which is the nature of the market." ”
Still, Salman Ahmed, Fidelity's global head of macroeconomics, argues that "central banks cannot afford to play the role of aggressive inflation fighters." In his view, the ECB will also face some particularly stringent restrictions in this regard, because the support of the ECB's monetary policy on the bond market is crucial to maintaining the unity of the euro area.