Because the ECB is between two fires
The Russian war against Ukraine puts the ECB in a complex position. Here because. The analysis by Martin Wolburg, senior economist at Generali Investments
The Russian war against Ukraine puts the ECB in a complex position. On the one hand, the skyrocketing prices of energy and raw materials in the aftermath of the Russian invasion add to an already high inflationary pressure that will persist. On the other hand, the spiral of sanctions and retaliation is moving rapidly and may not have ended yet. A complete cut of the Russian economy from global trade, by deliberately including oil and gas, remains a clear possibility. Euro area activity could take a severe hit as recession fears intensify.
At the meeting on Thursday, the updated macroeconomic projections will show a strong shift in inflation expected for 2022 (from 3.2% to the 5.5% – 6% range in our view), while the corresponding growth expectations will have to be revised ( from 4.2% to at least around 3% in our opinion). At the same time, both medium and long-term market-based inflation expectations broke away from the 2% threshold. The Board of Directors is therefore moving more and more towards a situation that Panetta has defined as “bad inflation”, that is, an unanchoring of inflation expectations.
In such a situation, the risk of political errors is high, as uncertainty is exceptionally high. Consequently, the latest comments from members of the Governing Council emphasize optionality as a key ingredient of an appropriate political position, the common denominator between doves and hawks. President Lagarde will probably emphasize this a lot during the press conference. While ending the PEPP program as planned, the increase in APP purchases to partially compensate for the missed purchases under the PEPP could be higher than previously thought (in the monthly range of 40 – 50 billion euros) and the Council Management could leave the indication about the end of APP purchases rather vague.
At the same time, in our opinion, the ECB will signal that, despite the Russian invasion, the normalization of politics is underway while its timing is heavily dependent on the evolution of the war and the impact on business. Either way, it will be a fine line between helping to reduce long-term inflation expectations again, while trying to cushion the fallout from the war on assets. President Lagarde will choose her words very carefully and perhaps the ECB could also propose new tools to deal with this exceptional situation. At the moment, we think the ECB is very likely to postpone its first rate hike to December.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/perche-la-bce-e-tra-2-fuochi/ on Wed, 09 Mar 2022 10:19:26 +0000.