Why the announcements of the ECB raise uncertainties and fears
What did the ECB decide and what impact the decisions will have. The analysis by Pasquale Diana, Head of Macro Research at AcomeA
No ambiguity: rates up 25bp in July, with another hike in September. Central banks often like to use very ambiguous language. This is not the case with the ECB yesterday, which announced the end of purchases in the APP program at the beginning of July , and a rise of 25bp on 21 July. The ECB adds that it intends to raise rates also in September, and indicates a more substantial rise (50bp) in the event that the inflation forecast does not improve between June and September. Beyond September, the ECB intends to continue normalizing rates, at a pace dictated by macro data and inflation. In the press conference, Lagarde emphasized the importance of quarterly forecasts (March, June, September, December) but clarified that she can change rates even after these dates.
The new forecasts: growth down, inflation up: The ECB has revised down this year's growth to 2.8% (from 3.7%), and 2023 to 2.1% (from 2.8%) , but revised up 2024, to 2.1% (from 1.6%). On inflation, the new estimates are 6.8% in 2022 (from 5.1%), 3.5% in 2023 (from 2.1%), and 2.1% in 2024 (from 1.9%). Core inflation also remains above the target throughout the time horizon (3.3% in '22, 2.8% in '23 and 2.3% in '24). In addition, the ECB sees inflation risks to the upside.
The long march of European rates towards more normal levels has therefore begun: How will this process be articulated? According to Lagarde's blog of May 23, this normalization consists of three phases: the first simply reflects the exit from the emergency rates justified by the pandemic (see normalization of inflation breakevens, for example); the second consists in approaching a “neutral” level (unspecified and not discussed today); eventually the third phase would bring the rates into restrictive territory (beyond the neutral level), in case of overheating of the economy. Given the spread of inflation – even in the face of analysts' forecasts that remain contained in the medium term – a normalization appears highly justified.
Explicit as much as possible, as ambiguous as necessary: In essence, the ECB has clearly hinted at the desire to raise rates to 75bp by September if inflation forecasts do not improve, to bring the deposit rate (-0.50%) into positive territory. From then on, the cycle will continue until it approaches a neutral rate, on which the ECB prefers to remain ambiguous for now, as well as observing that it is clearly positive (Schnabel) and is rising (De Guindos). Whether it is 1%, 1.50% or 2% is not a priority at the moment.
What about fragmentation? What would the ECB do if the spreads widened a lot? The perception is that the ECB does not want (can't?) Talk about a new anti-fragmentation tool because it would be a source of division at a time when there is unity of purpose in the Governing Council. The ECB has simply reiterated that it intends to use the reinvestments of the PEPP in a flexible way, between the various countries and the various asset classes. Lagarde adds that the ECB knows how to "design and implement" new tools if necessary. However, it must be admitted that it is not easy to design an instrument that resembles a purchase program to contain spreads at a time when the ECB is raising rates. What increase in spreads would be seen as unjustified? Would there be conditionalities for benefiting from this instrument, and of what kind? What would the ECB do with the liquidity created by the instrument? These are all questions on which finding a compromise would not be easy. That is why it is reasonable to assume that this instrument would only be created following very marked debt tensions in the eurozone periphery. We are not close yet.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/fatti-annunci-e-silenzi-della-bce/ on Fri, 10 Jun 2022 03:27:48 +0000.