ECB on hold but may acknowledge inflation risks

The European Central Bank is all but certain to keep policy unchanged on Thursday but could acknowledge that inflation could stay high for longer than it had projected, a signal that some may take as a hint at a faster exit from stimulus.

Having extended support measures as recently as December, any policy change now would be premature. Yet inflation has consistently exceeded the ECB’s forecasts, piling pressure on policymakers to fine-tune their increasingly questioned narrative that rapid price growth is merely temporary.

The bank argues that inflation will soon abate without its intervention and that long-term price pressures are actually too weak, meaning support is still needed to underpin inflation which undershot the ECB’s 2% target for much of the last decade.

This view is being challenged by investors and several policymakers, and January’s 5.1% inflation print, the highest ever for the 19-country euro zone, only adds to pressure for ECB President Christine Lagarde to acknowledge mounting risks.

“The ECB’s hopes for a rapid decline in the inflation rate are fading,” Commerzbank (DE:CBKG) economist Christoph Weil said. “The pressure on the central bank to exit its ultra-expansive monetary policy as early as 2022 is increasing.”

Inflation is forecast just below the ECB’s 2% objective in 2023 and 2024, meaning that even a small increase in the inflation path could put price growth right on target, reducing the need for stimulus.

But changing the inflation narrative is a tricky and potentially risky exercise.

Despite the ECB’s insistence that any change in interest rates this year is very unlikely, sceptical markets are already pricing in 28 basis points of hikes during 2022, with the first move in July.

If Lagarde admits that the ECB has underestimated price pressures, markets will bring forward rate-hike bets, tightening financing conditions and offsetting the very stimulus the central bank aims to provide.

German 10-year yields, a benchmark for the bloc, are already in positive territory, coming up from levels around -0.4% in late December. Stocks are meanwhile down around 2% since the start of the year.