Lagarde says Inflation likely to stabilize at 2%. EU nightmare as inflation and recession risk grows

Inflation has continued to surprise on the upside because of unexpectedly high energy costs. Price rises have also become more broadly based. The baseline for inflation in the new staff projections has been revised upwards significantly, with annual inflation at 5.1 per cent in 2022, 2.1 per cent in 2023 and 1.9 per cent in 2024. Inflation excluding food and energy is projected to average 2.6 per cent in 2022, 1.8 per cent in 2023 and 1.9 per cent in 2024, also higher than in the December projections. Longer-term inflation expectations across a range of measures have re-anchored at our inflation target. The Governing Council sees it as increasingly likely that inflation will stabilise at its two per cent target over the medium term.
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In alternative scenarios for the economic and financial impact of the war, which will be published together with the staff projections on our website, economic activity could be dampened significantly by a steeper rise in energy and commodity prices and a more severe drag on trade and sentiment. Inflation could be considerably higher in the near term. However, in all scenarios, inflation is still expected to decrease progressively and settle at levels around our two per cent inflation target in 2024.

ECB tries to get its bearings in the fog of war. ECB scales back stimulus plan as Ukraine war drives up inflation expectations. Bond markets view moves as hawkish while Lagarde calls Russia’s invasion a ‘major shock’ to eurozone economy.

The European Central Bank has scaled back its bond-buying stimulus plan in response to inflation being driven up by the war in Ukraine, while giving itself more flexibility on the timing of a potential interest rate rise this year.

“The Russian invasion of Ukraine is a watershed for Europe,” the ECB said in a statement after its governing council’s meeting in Frankfurt on Thursday, adding that it would “take whatever action is needed . . . to pursue price stability and to safeguard financial stability”.

Analysts interpreted the move to speed up the ECB’s exit from buying more bonds as a signal that it could raise interest rates in the fourth quarter in an effort to contain soaring inflation — which would be the first such move for more than a decade.

However, the ECB also gave itself more leeway to wait longer before raising interest rates after its bond-buying ends. “It is a bit of a mixed message, even though the market has interpreted it as hawkish overall,” said Dirk Schumacher, head of European macro research at Natixis.

Investors responded by selling eurozone bonds, pushing Germany’s 10-year yield to 0.27 per cent, the highest in more than three weeks. Riskier eurozone debt was also hit, with Italian 10-year yields climbing 0.2 percentage points to 1.89 per cent. Bond prices fall when yields rise.

“A faster winding down of the asset purchase programme will perhaps come as a surprise to market participants who expected an ECB capitulation in the face of weaker growth forecasts,” said Seema Shah, chief strategist at Principal Global Investors.

The euro briefly rose after the ECB announcement, before falling 0.6 per cent to $1.1013 against the US dollar.

Christine Lagarde, ECB president, said Russia’s invasion of Ukraine had created “a major shock” for the eurozone economy, adding that the central bank was forecasting higher inflation and lower growth over the next three years.

Setting out a quicker reduction in its bond-buying plans this year, the ECB said it would reduce asset purchases to €40bn in April, €30bn in May and €20bn in June. Its earlier plan was to steadily reduce net purchases from €40bn a month in April to €20bn a month from October.

It could stop adding to its existing €4.6tn bond portfolio in the third quarter “if the incoming data support the expectation that the medium-term inflation outlook will not weaken even after the end of our net asset purchases”.

The separate €1.85tn emergency bond-buying scheme launched in response to the coronavirus pandemic would stop net purchases as planned at the end of March, it said.

However, the central bank dropped a commitment to end asset purchases “shortly before” it raises interest rates, saying instead that any change to rates would be “gradual” and come “some time” after asset purchases end, which Lagarde said could mean months, or a week later.

The ECB cut its growth forecast for this year to 3.7 per cent, down from 4.2 per cent, and Lagarde said high inflation could put more downward pressure on demand. It raised its forecast for inflation this year from 3.2 per cent to 5.1 per cent. But crucially it predicted inflation would fade to 2.1 per cent next year and 1.9 per cent in 2024 — meaning it still has not fulfilled a key condition to raise interest rates.

“Inflation could be considerably higher in the near term,” Lagarde said. “However, in all scenarios, inflation is expected to stabilise around our target by 2024.”