Notwithstanding a substantial upward revision of its inflation forecasts due to soaring energy prices and heightened uncertainty resulting from the Russian invasion of Ukraine, the European Central Bank decided on Thursday 10 March to continue the gradual normalisation of its monetary policy, announcing in particular a reduction in the volume of its asset purchase programme (APP) for the second quarter of 2022. It promises to take “whatever action” necessary to contain price increases to 2% in the medium term and to ensure financial stability.
“The Russia-Ukraine war will have a material impact on economic activity and inflation through higher energy and commodity prices, the disruption of international commerce and weaker confidence”, said the president of the monetary institute, Christine Lagarde. However, it is too early to assess the exact extent of the impact of the war in Ukraine on the euro area economy.
Nevertheless, compared to December 2021 (see EUROPE 12855/8), the ECB has revised its GDP growth forecasts significantly downwards to 3.7% for 2022, 2.8% for 2023 and 1.6% for 2024.
According to the EU institution’s baseline scenario, growth is still expected to be robust this year, albeit at a slower pace than that expected before the outbreak of the Russian invasion. The recovery is based on solid economic fundamentals such as the lifting of health restrictions put in place to combat the Covid-19 pandemic, an observed increase in supply to meet demand and very low unemployment.
Moreover, the European financial system has little exposure to the Russian financial sector, which has been subject to unprecedented international sanctions, the latest of which was the suspension of the Bank of Russia from the Bank for International Settlements.
“Russia is important in terms of commodity prices. But in terms of the exposure of the European financial sector, Russia is not very relevant. The size of the Russian economy is relatively limited, roughly 2% of the world economy”, noted ECB Vice-President Luis De Guindos.
Nevertheless, downside risks have increased “considerably” and could weigh on the confidence of economic operators, said Ms Lagarde.
She considered that, in this context of renewed uncertainty, fiscal policies should continue to support economies at national and European level. It is up to EU leaders to decide, but “we have always argued for a European fiscal facility that can respond to shocks”, and we are facing a shock, the former IMF chief said.
Record inflation. “Inflation continued to surprise on the upside because of the unexpected increase in energy costs”, which jumped by “31.7% in February”, but also because “price increases have also become more generalised” and now affect “many other sectors” such as “food”, noted Ms Lagarde.
For example, the ECB has significantly revised upwards its short-term annual inflation projections to 5.1% in 2022, 2.1% in 2023 and 1.9% in 2024. The Governing Council therefore considers it increasingly likely that annual price inflation will stabilise at its target level of 2% over the medium term.
For this reason, it confirmed that the ‘PEPP’ operation of massive buybacks of mainly public securities launched to deal with the pandemic (see EUROPE 12855/8) would be halted by the end of March. It also decided to reduce its net purchases under the ‘APP’ operation in the second quarter, to €40 billion in April, €30 billion in May and €20 billion in June. For the third quarter of 2022, the discontinuation of purchases via the ‘APP’ operation is not excluded, but a decision to do so will only be taken if the available data confirm the inflation trajectory and the macroeconomic situation.
The discussions were “intense”, with divergent views expressed, but in the end all the governors agreed on the “balanced” proposal on the table, commented Ms Lagarde. She argued against any accelerated tightening of monetary policy. “The decision made was to move forward step by step, to acknowledge the added uncertainty we’re facing and to therefore have more options, so that in all circumstances we can respond in an agile way”, she said.
As for an increase in the ECB’s key interest rates in 2022, a possibility that its President had not ruled out at the beginning of the year (see EUROPE 12883/17), the Governing Council decided that any adjustment in this respect would be “gradual” and would take place “some time after” the completion of the APP operation. This language undoes the link that was previously established between these two measures.
For Ms Lagarde, the important thing is not the timing of events, but “the robustness of the data” available before any future decision on monetary normalisation is taken.
See the ECB decisions: https://aeur.eu/f/ps (Original version in French by Mathieu Bion)