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The European Central Bank will begin a new era of monetary policy this week as officials complete their pivot to confront the threat of inflation running out of control.
Armed with new forecasts and with prices rising at a record pace, President Christine Lagarde and her colleagues will end trillions of euros of asset purchases and cement a path to exiting eight years of negative interest rates.
While consumer prices surging at more than four times the 2% goal are alarming enough, it’s the outlook beyond the immediate term that will underpin the shift. Their projections are likely to show inflation won’t drop below the target again through 2024.
Those new quarterly numbers will be the first to fully account for Russia’s war in Ukraine, which no matter when it ends will have lasting effects on energy and food costs. The new reality will show that the ECB’s criteria for rate liftoff are finally met -- allowing it to join the Federal Reserve and its peers in hiking borrowing costs.
“With the forecast, they can show that their three conditions are fulfilled” to start removing stimulus, said Karsten Junius, an economist at Bank J Safra Sarasin in Zurich. “They can really close the old chapter and face the new threats.”
Those challenges stand in stark contrast to the picture pre-pandemic, when officials fought sluggish consumer-price growth that fell well short of their target -- a situation ECB researchers blame on past crises, demographics, globalization and digitization.
The turnaround has been dramatic. Inflation now tops 8%, driven by energy costs and logistics snarls. Even when those issues are overcome, the “disinflationary dynamics of the past decade are unlikely to return,” according to Lagarde.
Economists surveyed by Bloomberg see the 2024 inflation projection coming in at 2% -- up from just shy of that level in March. That would satisfy the ECB’s requirement that price growth not only quickens for a brief period, but remains elevated over the medium term.
The upshot will be a first rate increase in more than a decade in July, after net bond-buying is wound down. By how much is the subject of vigorous debate within the Governing Council, where some want a half-point hike.
Most economists see only two quarter-point moves -- next month and in September. But Bank of America (NYSE:BAC) last week changed its view, predicting steps of double that amount at each of the two meetings.
Lagarde has portrayed Russia’s invasion as a pivotal moment that may prove to be a “tipping point for hyper-globalization,” while speeding up the green transition -- both implying more durable inflation pressure. She’s charted a course out of subzero rates by October in a return to more “normal” settings.
But despite the ECB acting much more slowly than its peers, some still fret that it’s moving too rapidly as the continent’s pandemic rebound runs up against the price shock and dwindling confidence over the war.
As the cost of staples soars, almost half of German citizens say they’ve had to cut back strongly or very strongly on consumption, according to a survey published last week.
“There seems to be a priority in this Governing Council to signal they’re doing something on inflation even though there are growth risks,” said Evelyn Herrmann, an economist at Bank of America in Paris. “It’s a very single-sided discussion that largely ignores risks that inflation could move the exact opposite way.”
Calls to move slowly to account for an uncertain economic environment have become more rare. But even when they’ve come -- like from dovish Executive Board member Fabio Panetta -- there’s been an acknowledgment too that rates must rise from record lows to keep price expectations in check.
Spain’s Pablo Hernandez de Cos, another dove, last week summed up the change of tone that’s left only the size of the initial rate hike in question.
While stressing that policy-normalization must be “gradual,” he said, “it’s crucial that inflation expectations remain anchored and significant indirect or second-round effects that could put that anchoring at risk are avoided.”
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