Francesco Canepa and Balazs Koranyi

FRANKFURT, (Reuters) – The European Central Bank will likely keep its policy the same on Thursday. It is expected to counter growing expectations of an increase in interest rates next year. However, it might admit that inflation may be higher than anticipated.

Christine Lagarde (ECB President) will be setting the tone for rolling back emergency stimulation after she has already announced major policy decisions that are coming in December.

However, she will be highlighting once more the fact that the ECB does not plan to increase its policy speed, even if other banks do.

However, she will need to convince investors that it is the best path. The ECB’s claim that inflation is temporary means rate increases are not likely to be repeated has been questioned by investors.

The result is a large gap between the market’s expectations and bank guidance, which states that rates would remain low until inflation stabilizes at 2%.

Markets are pricing in a possibility of a hike next fall and expecting inflation to hover around the ECB’s target level over the coming years. This is far from the banks projections.

Philip Lane, the chief economist of the ECB has already attempted to defy these expectations. He claimed that they are “challenging and difficult to reconcile with” their own guidance.

However, that intervention only had a small effect so Lagarde might need to make it clearer that investors are wrongly reading the central banks.

Inflation is the main reason for this disconnect. According to analysts, inflation will cause price growth to reach 4% this year, which is twice what the ECB targets. This could be due to a variety of factors that are not considered normal. It may also sink further than the ECB would like to admit.

Although temporary, such an increase in price could cause underlying pressures to rise and impact wages setting if the effect lasts.

Companies may have to adapt their pricing strategies to reflect higher energy costs.

Although the ECB insists that this is unlikely, markets have a different opinion.

Marco Valli, UniCredit’s economist, stated that Lagarde “should, and will likely try to,” counteract this repricing with more force.”

“An important feature of the ECB’s rate guidance, which markets may now be overlooking, is that its formulation greatly reduces the scope for pre-emptive tightening.”

Attention

The ECB will likely decide in December to stop emergency stimulus. However, it could increase another support program to take up some of the slack, and help keep borrowing costs low.

There are many reasons to be cautious.

Hard data doesn’t show alarming wage hikes, which would indicate more durable inflation. Analyst forecasts also fall below the ECB criteria for raising rates.

The ECB also has undershot its targets for almost a decade, so a premature move could be a disaster.

The bank’s rate rise on the eve the debt crisis in Europe a decade ago is a policy mistake that many think was the worst.

Commerzbank economic Michael Schubert (DE) stated, “The ECB will raise rates but it won’t be enough that wages rise again in the face a improved labour market situation and high inflation rate.”

He stated, “Rather they would need to rise so quickly and so strongly that it is impossible for inflation to fall due to expiry of temporary effects in the next year.”

A notable slowdown in economic activity in the next quarter is another argument in favor of tighter policies.

Growth is unlikely to pick up in the bloc, as many industries are suffering from supply problems. Services will also likely be affected by the new coronavirus pandemic.

This all suggests a prudent tone by the ECB, with a repetition of the argument that the elimination of emergency stimuli is simply a recalibration in policy and not the withdrawal from support.

At 1145 GMT the ECB will announce its policy decision. Lagarde will then hold a news conference at 1230 GMT.