Mike Dolan

LONDON (Reuters). The European Central Bank’s decision that it would keep tightening despite the fear of war and stagflation is being criticized for either bluffing, or as an error. But this may simply reflect a change in Europe’s economic policies.

Thursday’s meeting of the ECB was the first among the ‘Big Four’ banks to take place since Russia’s invasion and subsequent energy price explosion. Markets were on edge over whether to focus their attention on inflation or growth.

It was a surprise to many investors that the company chose for the former. This allowed it to accelerate the closing of its major bond buying program through the third quarter, and place market bets regarding interest rate rises at the end.

ECB policy and inflation https://fingfx.thomsonreuters.com/gfx/mkt/lgpdwaeykvo/One.PNG

Euro sovereign bond yields and euro FX https://fingfx.thomsonreuters.com/gfx/mkt/egvbkqwdmpq/Three.PNG

The ECB rates rises at yearend are discounted almost by 45bps on the money market – bringing its negative deposit rate to near zero for the first eight years. This is a significant improvement over the 30bp hikes that occurred just prior to this meeting. In addition to the possibility of less bond purchases, an end in negative interest rates caused euro government bonds to crash and sent long-term borrowing cost across the area surging.

Cover for the ECB’s hawkish tilt were revised forecasts that showed inflation above its 2% target next Year – a greater landing point than last year’s record 5.1%.

Yet, it made loud comments about Ukraine and high energy prices. It also cut the year’s forecast growth by half a points to 3.7%. The “alternative” scenario was the worst case. Christine Lagarde (ECB chief) spoke of “huge uncertainties” and stressed that there was “maximum option” and “maximum agility, and flexibility”.

This is how investors realized a false sense of security.

Anna Stupnytska, Fidelity International’s Anna Stupnytska stated that the Ukraine energy shock could cause the euro area to enter recession during the second half year. Market pricing is also a concern.

She stated that “we don’t expect the ECB will raise rates this year, despite changes in market prices.” The risk of more QE is greater than the possibility that gas supplies to Europe from Russia are interrupted in the future.

Gurpreet Gill, Asset Management (NYSE:), Goldman Sachs (NYSE :), also doubts the possibility of a rate rise in 2022. She stated that prospects for such an increase were “limited.”

Other commentators suggested that it was possible for this week’s plans to be reversed.

Federated Hermes (NYSE)’s Silvia dall’Angelo explained that the ECB will proceed cautiously and slowly if there is war-related uncertainty. In the event of a catastrophic outcome, the ECB may have to use an emergency package to delay lifting off.

NEEDLE AND COMPPASS

This possibility of a downturn reminded many people of Jean Claude Trichet (ex-ECB chief)’s quick reversed attempts to increase interest rates at the time of the 2008 bank crash. Also, as the 2011 euro sovereign debt crisis raged, Trichet tried again and failed. He claimed that the ECB was solely concerned with inflation and had no mandate.

Andrew Mulliner, Janus Henderson Investors, stated that there was an unkind smuggling of Trichet’s “there is only one needle within our compass” in some actions. This line has been associated with central banks obstinance, and eventually policy error.

It is difficult to understand exactly what the ECB was trying to accomplish today.

Charles Hepworth, GAM Investments, was equally critical. “It all feels like a déjà vu sense of continual policy mistakes by the ECB,” he said

Yet, many others sympathize more with the central bankers who are caught in a difficult spot right now and face a unenviable mixture of war and inflation.

Seema Shah, Principal Global Investors, stated that if there is a prolonged conflict and high energy prices impact on households and confidence, it will be extremely difficult for the ECB to increase rates this year. Who would ever want to serve as central banker under this circumstance?

Reuters sources claim that the Asset Purchase Scheme was not ended by a few members of the ECB’s governing Council at the close of Q3.

Many suspect that, faced with both energy-spurred inflation and demand destruction, European Union countries will be on an “economic warfare” basis and their central bank will split the challenge of policymaking more evenly than the previous 12 years.

Inflation was absent for many years, and Germany insisted on tightening euro budgets by triggering sovereign debt crises a decade before. This meant that cyclical credit demand and management were almost exclusively left to the ECB.

However, inflation is expected to return, which was exaggerated due to the oil and gas squeeze surrounding Russia’s invasion in Ukraine. The ECB might now view its primary job as normalizing monetary policy, while governments will pay more for the relief of household incomes.

The counter punch to this week’s ECB action is this week’s EU Summit in Versailles.

Federated Hermes’ Dall’Angelo said that it looked like fiscal levers at the EU as well as the national level will be required to deal with the potentially negative consequences of the conflict in Ukraine.

Problem is, by focusing on a strict end to the purchase of new assets rather than the increase in policy rates, the ECB has spooked bond markets that are needed to fund the fiscal offset. The question is, who would be a good central banker?

The editor-at-large of finance and markets for Reuters News is the author. All views and opinions expressed in this article are the author’s.

(by Mike Dolan. Twitter (NYSE::): @reutersMikeD. Editing by Andrew Heavens