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ECB seen on hold but may acknowledge inflation risks -Breaking

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© Reuters. FILE PHOTO – The European Central Bank’s headquarters are pictured in Frankfurt (Germany) on July 8, 2020. REUTERS/Ralph Orlowski/File photo/File photo

Francesco Canepa & Balazs Coranyi

FRANKFURT (Reuters – While the European Central Bank appears to be certain of keeping policy unchanged on Thursday, it may have to accept that inflation might stay higher for longer than anticipated. Some may interpret this signal as a clue to a more rapid exit from stimulus.

Since December was the last time support measures were extended, it would seem premature to make any changes in policy now. However, inflation continues to exceed the ECB’s predictions. This puts pressure on policymakers for a more accurate narrative that price growth is temporary.

According to the bank, inflation is unlikely to rise without intervention. Long-term price pressures will be too low for inflation. This means that support must still be provided in order to maintain inflation that has been below the 2% target of the ECB over much of the past decade.

This viewpoint is being challenged now by several investors as well as policymakers. The January 5.1% inflation print (the highest for any of the 19-country euro area countries) only puts pressure on Christine Lagarde at ECB to recognize mounting risks.

Christoph Weil, Commerzbank (DE) economist said that “The ECB is losing its hopes of a rapid fall in inflation rates.” The pressure is growing on the central bank for it to end its excessively expansive monetary policy by 2022.

It is risky and difficult to change the inflation narrative.

The ECB has been doubted by markets. They are now pricing in rate rises of up to 30 basis points in 2019, despite the fact that it insists on not making any moves in 2022.

Lagarde’s admission that the ECB underestimated price pressures will cause markets to bring rate-hike wagers and tighten financing conditions forward. This would offset the very stimuli the ECB aims for.

CREDIBILITY

Lagarde can’t ignore inflation overshoots, despite Lagarde’s already shaky credibility.

She may instead offer an innocuous nod to inflation risk while emphasizing the fact that the price rise in Europe is fundamentally different from that in America due to weak wage pressures, relative slow recovery of consumption and relatively low wages.

The U.S. Federal Reserve is signalling a first rate hike in March although officials spoke cautiously on Monday https://www.reuters.com/business/fed-officials-say-march-rate-hike-track-future-increases-data-dependent-2022-01-31 about what might follow.

In the meantime, it is expected that the Bank of England will raise rates on Thursday. It also signaled its intention to gradually reduce its large holdings of government bonds. These were bought in order to stimulate Britain’s economy.

Lagarde might need to recognize that the labour market is tightening faster than anticipated, even though it hasn’t brought about significant wage pressures, as unemployment continues to fall to an all-time low.

However, her message to the public is likely to remain that no rate increase is expected this year. A framing which leaves open the possibility of an increase in borrowing cost in early 2023.

Markets have always been more prudent than analysts, so rate-hike predictions are being made by analysts. A Reuters poll showed that the first ECB rate hike was expected to occur in the fourth quarter 2023. However, a rising number of analysts now expect a rise as soon as Q1.

Capital Economics chief Europe economist Andrew Kenningham said, “For the moment, we have pencilled the first rate rise for early 2023 but an increase by the end of next year is increasingly likely.”

Lagarde will not change her opinion that inflation will return to target by year-end. However, this important provision should help keep rates hike fears at bay.

Lagarde will hold a news conference at 1330 GMT while the ECB announces its policy decision.

The ECB will keep its deposit rate at a record low of minus 0.5%, and continue to work towards the elimination of the 1.85 trillion Euro pandemic bond buying program by March 31st.

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