Francesco Canepa & Balazs Coranyi

FRANKFURT, (Reuters) – The European Central Bank will end asset purchases during the third quarter. This surprise decision was made by it on Thursday. It did so because rising inflation is outweighing concerns over Russia’s invasion of Ukraine.

The record-breaking price rise in the euro area was evident even before Moscow launched its attack on February 24, and policymakers had already pushed for a faster exit from asset purchases to allow for an increase in interest rates late this year.

The war, however, has meant that this opinion is not supported. However the February record rate of 5.8% (and the possibility of another even higher reading in March) put increased pressure on Bank of England to follow its mandate and keep price growth below 2%.

Investors were surprised by the move, as they had expected that the ECB would make as few commitments possible. It will keep its options open while more information is available about the war and sanctions’ impact on commodity prices.

The bank announced Thursday that it will close its Pandemic Emergency Purchase Programme of 1.85 Trillion Euros at the end the month. It also confirmed that purchases made under the stricter Asset Purchase Programme, (APP), would be less than originally planned.

The company now anticipates that APP purchase will total 40 billion euro in April, 30 million euros in May, and 20 billion in June. It had previously established purchases of 40billion euros for the second quarter. 30 billion euros was the third quarter. 20 billion were the fourth quarter.

According to the ECB, purchases for the third quarter are “data dependent”, adding that they could be revised if there is an improvement in inflation.

According to the ECB, “If the incoming statistics support the assumption that medium-term inflation outlook won’t weaken even though we have ended our net assets purchases,” the Governing Council will end net asset purchases in the third quarter under the APP,” the statement read.

Additionally, it stated that adjustments to interest rates would take place after asset purchases are over and that these changes would be gradual.

On the announcement, the euro quickly settled, which was seen as a minor victory by conservative policymakers. Additionally, bond yields rallied.

The yields on ten-year German bonds rose by 7 basis points upon the decision, while the euro traded at 1.108 against 1.104 prior to the decision.

Now, markets expect to see interest rate increases of approximately 43 basis points this year, which is an improvement on the 30-basis point prediction before the meeting.

“All in all, today’s decisions are a good compromise, keeping maximum flexibility in a very gradual normalisation of monetary policy,” ING economist Carsten Brzeski said. A first rate increase before the end is possible.”

Now, attention turns to Christine Lagarde, President of the ECB. She will be presenting new economic projections at her 1230 GMT news conference.

UNAVOIDABLE

Although it was unexpected that the ECB made this move, normalization of policy was seen as inevitable.

The ECB could target inflation in 19 euro-using countries at three times its 2% target for this year. It is also likely that it will remain high next year.

The ECB should be encouraged by a rebound in economic growth, tighter labour markets in recent decades to end its decade-long experiment in unconventional stimulus.

Reuters polled economists before the meeting and found that they expected bond purchases to stop in the third quarter, with rates rising in the fourth. [POLL/]

In order to curb what was at the time sluggish inflation within the euro zone, the ECB has maintained a low rate of deposits, charging banks for cash to be stored in their bank accounts.

However, the conflict in Ukraine at the eastern border of the euro zone could change the outlook.

Western nations will impose unprecedented sanctions on Russia. In addition, rising commodity prices and uncertainty will increase uncertainty, slow growth and reduce households’ purchasing power.

Some policymakers also argue that the high commodity prices can be deflationary for households in the long-term because they will have to pay higher fuel bills, which in turn will reduce their ability to purchase other products.