ECB sticks to plan for gradual tightening of monetary policy

The European Central Bank on Thursday stuck to its gradual timetable for winding down bond purchases in the third quarter without putting a firm date on when it will raise interest rates despite record-high eurozone inflation.

Policymakers on the central bank’s governing council, who met this week in Frankfurt, face a dilemma of how to drastically tighten monetary policy in response to record inflation while the risk grows of a sharp economic downturn caused by the fallout from Russia’s invasion of Ukraine.

The ECB kept its main policy rate unchanged at minus 0.5 per cent and repeated its statement that the “calibration of net purchases for the third quarter will be data-dependent and reflect its evolving assessment of the outlook”.

“How the economy develops will crucially depend on how the [Ukraine] conflict evolves, on the impact of current sanctions and on possible further measures, ”the ECB said.

“Inflation has increased significantly and will remain high over the coming months, mainly because of the sharp rise in energy costs,” it said, adding that in light of the uncertainty it would maintain optionality, gradualism and flexibility in the conduct of monetary policy ”.

Markets are pricing in an increase in the ECB’s deposit rate back above zero by the end of the year and to almost 1.5 per cent by the end of next year. But the central bank said any rate rise would be “gradual” and would only take place “some time” after it stops net bond purchases.

In contrast, many other central banks have already stopped buying bonds and started raising rates. This week, the Reserve Bank of New Zealand and the Bank of Canada both raised rates by half a percentage point, while monetary authorities in South Korea and Singapore also tightened policy.

The US Federal Reserve is expected to raise rates by as much as half a percentage point at its policy meeting in May, while the Bank of England has increased its main rate three times since December and is expected to do so again at its meeting next month.

The ECB accelerated its timetable for ending net bond purchases at its meeting last month. Since then eurozone inflation has risen to a new record high of 7.5 per cent in March, intensifying calls for the central bank to move even faster in withdrawing its stimulus.

However, the ECB continues to forecast that inflation will dip back below its 2 per cent target in two years’ time, as energy prices retreat from their recently elevated levels and supply chain bottlenecks ease.

Eurozone sovereign bond markets have already sold off since the start of this year, as investors anticipate that soaring inflation will force the ECB to stop buying bonds and start raising rates soon.

Germany’s 10-year bond yield, a benchmark for Europe’s debt markets, has surged out of negative territory at the start of this year and risen to more than 0.8 per cent, close to its highest level since 2015.

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