Obviously, the war in Ukraine triggered by the invasion of the Russian army and its particularly economic impact on the whole of Europe did not prevent the European Central Bank (ECB) from announcing on Thursday a tightening of its Monetary Policy. This will take the form of an end to its bond buyback program in the third quarter, the first stage in the normalization of its monetary policy and the end of its policy of supporting the euro zone economy.
More specifically, purchases made under the Pandemic Emergency Purchase Program (PEPP), launched in March 2020 and endowed with 1.850 billion euros, will be definitively stopped at the end of March. And if the APP program, older and with less flexible conditions, will take over, its purchases will be reduced more quickly than expected: from 40 billion euros in April, they will fall to 30 billion in May and 20 billion in June. Previously, the ECB forecast monthly purchases of 40 billion euros in the second quarter, 30 billion in the third and 20 billion in the fourth.
In response to this less accommodating stance than expected, opting for cautious flexibility in a context of conflict in Ukraine, European stock markets ended in the red. The indices ended in sharp decline in Paris (-2.83%), Frankfurt (-2.93%), Milan (-4.20%) while investors expected a more flexible tone from the ECB. London ended down 1.54%.
“A mistake that might be costly”
“The whole thing is unquestionably more severe than expected, propelling the euro and future rates well above their level of recent days. This decision, which is largely incomprehensible, in the current context, is very unwelcome. Likely, in particular, to create the conditions for a rapid rise in rates and a sharp renewed concern regarding the sovereign outlook, with the very probable key to tensions in spreads (deviations) rate. Italian 10-year bonds have soared by 23 basis points (bp) since the publication of the press release and French bonds by 19 bp, once morest an 8 bp rise in the Bund. Once once more, the ECB seems to be making a mistake which is likely to be costly”judges the economist Véronique Riches-Flores.
As usual, cautious, the ECB specifies that the amounts for the third quarter may be modified according to the evolution of economic and financial indicators. “If the medium-term inflation outlook changes and financing conditions no longer allow further advances towards the 2% target, the Governing Council stands ready to revise both the volume and the duration of its purchases net of assets”explains the institution in its press release.
A “gradual” increase in interest rates
As for the rise in interest rates, it would only take place “After some time” the end of shopping and she would be “progressive”. “Obviously ‘sometime following’ is an open time horizon that depends on the data”said Christine Lagarde, during her press conference, adding that this interval might range from one week to several months.
“A rate hike at the end of the year therefore became possible once more. And this is a compromise. We cannot imagine what his decision would have been if the geopolitical risk were not so high. But like all compromises, this one risks not satisfying anyone.Faced with such a powerful external inflationary shock, the monetary response does not seem to be the best suited.
After its 180° turn last month, we expected a little more readability in a particularly anxiety-provoking context. Uncomfortable, the ECB is no longer master of time. She felt that the situation in the bond market was not comparable to that of the early days of the pandemic and therefore did not require support from her. Let’s hope that investors do not take her at her word by testing her intentions of intervention”comments Ronan Blanc, analyst manager at Financière Arbevel.
This compromise within the ECB results from the positions of the members of the council in the face of rising inflation. In the euro zone, it reached a record level even before the outbreak of the conflict in Ukraine on February 24, with a rate which stood at 5.8% in February over one year, following 5.1% in January. The most orthodox members of the ECB’s Governing Council were campaigning for an early end to unconventional measures, before a first interest rate hike before the end of the year. But the “doves” of the Council pleaded to take into account the impact of the situation in Ukraine, which will result in the continuation of the rise in prices moving away quickly from the target objective of 2%, which must be aimed at the institution, whose primary mission is price control.
The conflict in Ukraine is a “turning point” for Europe
“The Russia-Ukraine war will have a significant impact on economic activity and inflation through lower energy and commodity prices, disruptions in international trade and deteriorating confidence”recognized Christine Lagarde, considering that this conflict constituted a “turning point” for Europe. The Frankfurt institution has also revised its growth estimates for this year and next year downwards, but it has raised its inflation forecasts to 5.1% for this year once morest 3.2% forecast in December and to 2.1% once morest 1.8% for 2023. The rise in prices should nevertheless return to 1.9% in 2024, which would correspond to the objective of the central bank.
“Risks surrounding the economic outlook have increased markedly with Russia’s invasion of Ukraine and are on the downside”added the President of the ECB, specifying nevertheless that on this point there were different analyzes within the Council on the consequences of this situation, with obviously the supporters of a harder line.
“Only a fortnight ago it was expected that the ECB would announce a normalization plan today, involving a fairly rapid halt in asset purchases and then without delay a hike in the deposit rate. t was in peacetime. In wartime, in other words faced with a shock that is both inflationary and recessionary, the ECB can only be a little more cautious. It nevertheless announces a “tapering” (reduction) accelerated asset purchases, while being a little more patient on rates. The hawks have the upper hand in the future direction of policy at the ECB”considers, for his part, Bruno Cavalier, economist at Oddo BHF.
“A very uncertain future”
Christine Lagarde has also indicated, herself, that the economic impact of the Covid-19 pandemic easing, the recovery of the labor market and the prospect of a reduction in tensions affecting supply chains showed that the euro area was generally healthy.
An economic situation which obviously gives rise to two different readings of the monetary policy to be followed, but which agree on one point, underlined twice in the press release: we are “in a very uncertain future”.
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