Francesco Canepa & Balazs Coranyi

FRANKFURT, (Reuters) – The European Central Bank will likely make as few as possible policy commitments on Thursday. This is because the shock caused by Russia’s invasion in Ukraine has upended its economic expectations and left policymakers confronted with new realities.

The eurozone’s inflation rate was at an all-time high, well before Moscow started its offensive on February 24th. Policymakers expected to announce an end of years worth of stimulus spending. It would open the door to an interest rate increase late in this year.

However, the war has shattered any consensus. The 25-member ECB Governing Council is going to the meeting separated. It raises the likelihood of a policy surprise and also the risk for an error.

“No one can seriously expect the ECB to start normalising monetary policy at such a moment of high uncertainty,” ING economist Carsten Brzeski said.

It would be safest for the bank confirm its earlier decision to reduce bond purchases in next quarter, while keeping all other commitments up, such as an end-date to buy bonds and the timing for a rate increase, up in the air.

“We believe the ECB will aim to buy some time by proceeding with the previously planned gradual tapering in April … while increasing flexibility in the forward guidance to allow more room to act once the immediate fog lifts,” Societe Generale (OTC:) economist Anatoli Annenkov said.

“As long we don’t fall into recession (which is our baseline), we expect that the ECB will conclude this spring that its policy stance needs to be tightened faster in order to stabilize inflation expectations.”

Three times as much inflation could occur in the 19 euro countries than the ECB has aimed for. This year’s target of 2% is unlikely to be met next year.

An increase in economic growth should prompt the ECB’s to change its policy stance from ultra-easy and begin a nearly ten-year-long experiment using unconventional stimuli.

Federal Reserve will continue to increase U.S. interest rate next week. This is the beginning of a series of borrowing cost increases as inflation rises.

However, Russia’s conflict with Ukraine, unprecedented sanctions by Western nations on Russia, and rising commodity prices all increase uncertainty. They will reduce growth and affect household purchasing power.

Some policy hawks will still push for the ECB’s curbs on stimulus and to return policy to at least a neutral setting. This could mean that the bank might signal an end to bond purchases in the next months. A decision which would increase the likelihood of — but certainly not cement — a rate rise in 2022.

It is expected that the bank will drop all references to a rate reduction in its guidance and could remove any stipulation that an increase would occur “shortly” following bond purchase ends.

STUCTURAL WORSIES

Thursday will see the end of the stimulus program, even though high inflation is making it almost impossible to remove the stimulus. The real problem, however, is the impact that a new world order on prices, which has a longer time horizon for the ECB.

Inflation will be lower if there are high energy prices. This is because families and businesses have less money to invest and they delay their investments.

This is the reason why the ECB’s 2024 inflation forecast is not likely to differ from its 1.8% prediction three months ago.

Recent months have seen these forecasts so unpredictable that policymakers openly question their reliability, which has made them less pertinent in decision-making.

Also, war in Ukraine will likely set in motion economic forces that could increase prices.

Both increased defence spending as suggested by euro zone member countries and a faster green transition to remove Russia from the bloc are likely to increase government spending and inflation.

They may be backed with joint European Union debt issuance. The bloc will likely turn to the ECB for help in keeping its borrowing costs down.

The inflation cost of long-term decisions is difficult to estimate. However, ECB projections won’t reflect these costs, even if policymakers may raise them.