Francesco Canepa & Balazs Coranyi

FRANKFURT, (Reuters) – The European Central Bank could outline Thursday a more detailed schedule to unwind its extraordinary stimulus. This is because worries about record-high inflation outweigh concerns over a possible war-related recession.

Although the ECB has reduced the speed of its money printing programme over the past months, it has not yet committed to an end date. This is because they are concerned about the possibility that rising energy prices and the conflict in Ukraine could change their outlook.

This is far worse than most other central banks. Many of them have raised interest rates since last year. Within the span of two days, New Zealand, South Korea, and Canada all increased the costs of borrowing. [TOP/CEN]

Currently, the ECB intends to stop bond purchases (also known as quantitative easing) at some point during the third quarter. After that, interest rates will rise for “some time”.

The schedule was approved by the Governing Council last month. However, it is now being challenged.

The inflation rate has already reached a new record of 7.5% and there are still more. However, both the economy and households are experiencing stagnation in the bloc, as a result of the war’s impact.

Nick Kounis from ABN Amro said, “Given uncertainty highs (the ECB), will likely to want to keep the optionality and flexibility.”

“However the hawkish tone will likely intensify. It is clear that net asset purchases are likely to end and then higher policy rates to follow.”

Indeed, many conservative policymakers have argued in favor of higher interest rates. This is because they are concerned about high inflation.

Adding to this hawkish argument, long-term inflation expectations (a key indicator for policy credibility) have moved significantly above the ECB’s 2% target. This is despite the fact that wages are yet to adjust to higher prices.

RATE HITES?

Although the policy outlook is likely to stay unchanged at Thursday’s meeting, Christine Lagarde (ECB chief) could feel pressured to show more firmness that she will reduce support in the next few months.

Pictet Strategist Frederik ducrozet suggested that Lagarde might hint at a conditional ending of asset purchases in June. This could open up the possibility for a first rate increase in September. She could also choose to not push back against the market pricing which would be consistent with September’s liftoff.

Lagarde, who contracted COVID-19 in the last week, said her symptoms were mild.

The market prices in a total of 70 basis points in increases in the ECB’s minus 0.5% Deposit Rate this year. This is despite the fact that none of the 25 policymakers at the ECB have called for tightening.

Economic outlook that is quickly deteriorating is fuelling the caution of policymakers.

The high energy costs are reducing household savings, and the uncertain future of war has halted corporate investment. The downturn is also being exacerbated by the fact that banks are restricting credit access as they do in wartime, which could lead to increased borrowing costs.

According to policy doves, most inflation stems from external shocks. Therefore, inflation will fall naturally over time.

High energy prices are deflationary in the long-term because they slow growth. There is also a chance of inflation dropping too low.

It is important to ask whether Russia’s energy flow will be steady. Reinhard Cluse, UBS economist, stated that volume restrictions could lead to a greater risk of Eurozone recession. This would prompt the ECB to exercise more caution.

Nevertheless, when you consider the opposing forces, it is more likely that the ECB will face higher inflation risk, even though policymakers continue to make small adjustments and are ready to alter course at short notice.