By Geoffrey Smith
Investing.com — The European Central Bank shifted marginally in the direction of increasing monetary stimulus to the Eurozone economy Thursday, but disappointed many who had expected it to pursue its new, higher, inflation target with more zeal.
The ECB said it expects to continue buying bonds at an elevated pace over the next two months, re-asserting its determination to steer against expectations of an early tightening of monetary policy due to a spike in inflation in the first half of this year.
It also said it won’t raise interest rates until its new goal of a 2% inflation rate is well within reach, and until its Governing Council thinks that underlying price pressures are strong enough to keep it around 2% in the medium term. The new language appears designed to rule out any tightening of policy until a sustained rebound in inflation has already taken place.
The change in the ECB’s guidance comes a week after the bank adopted a new inflation target of 2%, something that allows it a slightly higher tolerance threshold for above target inflation. The ECB said that its new approach “may also imply a transitory period in which inflation is moderately above target.”
The foreign exchange market was unimpressed by the announcements, leaving the euro just above $1.18, slightly higher than before the meeting. However, European government bond markets interpreted the new guidance as pushing back the end of extraordinary liquidity support for the economy. The yield on the benchmark 10-year Spanish and Italian government bonds fell by 5 and 4 basis points, respectively, in response.
“The problem with the new ECB statement is that it has no teeth,” said Arne Petimezas, an analyst with AFS Group in Amsterdam “I get it that they want higher inflation and that they’re more tolerant of inflation. But they’re not willing to do more to reach their goal, except promises of easy policy for longer.”
Eurozone inflation rebounded to around the 2% level in the second quarter, but the move was largely due to changes in energy prices, which had collapsed in the early stage of the pandemic last year. By June, however, the headline annual rate of consumer inflation had already eased to 1.9% from 2.0% in May. In the opening statement at her subsequent press conference, ECB President Christine Lagarde said that the bank expects inflation to rise further over the rest of the year, before falling back.
“Weak wage growth and the past appreciation of the euro mean that price pressures will likely remain subdued for some time,” Lagarde said. While she said the bank expects the Eurozone economy to recover to pre-pandemic output levels by the end of the first quarter of 2022, she noted that the spread of the Delta variant of Covid-19 represented a clear threat, especially to services and the tourism sector.
Her warnings came only minutes after German media reported that Berlin intends to add Spain and the Netherlands to its list of ‘high risk’ areas, meaning that incoming travellers from those countries who are not fully vaccinated must quarantine. That threatens to deal another blow to Spain’s tourism-heavy economy in particular.
Guntram Wolff, a director with the Bruegel think-tank in Brussels, pointed out that the wage pressures needed to create a sustained rise in inflation are still largely absent – at least in Germany, the Eurozone’s largest economy, which traditionally acts as a benchmark for the rest of the bloc.
“There is no evidence in the recent data that German wage pressure is building up,” Wolff argued in a blog post published before the ECB meeting. “Agreed wage increases have been lower during the pandemic and forecasts and settlements for 2022 do not suggest any unusual increase.”
There were few other concrete changes to the ECB’s policy statement which, like its predecessors, remained guarded and carefully hedged despite President Christine Lagarde’s previous promise of language that would be “crispier” and “straight to the point”.
The bank’s language on possibly not using all of the resources of its 1.85 trillion euro Pandemic Emergency Purchase Program remained unchanged, and it repeated its pledge to keep reinvesting the proceeds from maturing bonds through the end of 2023.
Lagarde said that changes to current policy hadn’t figured in Thursday’s debate. While some analysts argue that the bank will have to increase monetary stimulus to reach its new target – after a decade of undershooting its old one – the ECB typically prefers to change policy when it updates its forecasts for Eurozone growth and inflation. The next update is due at its policy meeting in September.
ECB Issues New Guidance, Sees Bond Buying Continuing at Elevated Rate