The European Central Bank on Thursday kept its monetary policy unchanged, but confirmed that it will stop its bond purchases in the third quarter.
The Governing Council is facing a dilemma in which inflation hit a record 7.5% in March, while the outlook for economic growth is weakening due to the war in Ukraine.
The ECB said in a statement on Thursday that it now expects to complete its purchases of net assets under its APP (asset buying program) in the third quarter. It had previously said that this would be the approach if supported by the data.
“At today’s meeting, the Governing Council assessed that the data received since the last meeting reinforces its expectation that the purchase of net assets under the APP should be completed in the third quarter,” the bank said on Thursday.
Once the bond buying program is completed, the ECB is expected to start raising interest rates in the same way as the Bank of England and the US Federal Reserve.
The interest rates on the ECB’s main refinancing operations and the interest rates on the marginal lending facility and the deposit facility remain unchanged at 0.00%, 0.25% and -0.50% respectively.
“Any adjustment of the ECB’s key interest rates will take place some time after the end of the Governing Council’s net purchases under the APP and will be gradual,” the bank said in a statement.
“The path of the ECB’s key interest rates will continue to be determined by the Governing Council’s forward-looking guidance and by its strategic commitment to stabilize inflation at 2% over the medium term.”
Bond purchases under the ECB’s 1.85 trillion euro ($ 2 trillion) Pandemic Emergency Purchase Program, or PEPP, ended in March. Purchases under the older APP, however, were used as a bridge through the end of the PEPP.
Economists had broadly expected the ECB to keep policy stable for the time being and lay the groundwork for action at its meeting on 9 June, once the uncertain outlook for growth and inflation has been established.
The minutes of the last meeting on 10 March showed that the Governing Council was engaged in a fierce discussion on the pace of policy normalization.
The war in Ukraine and subsequent heavy sanctions against Russia, bottlenecks in the supply chain, high energy prices and concerns about a general shortage of raw materials needed for many industrial processes have significantly darkened the economic outlook.
At the same time, inflation continues to rise, and there are preliminary indications that this increase is not solely driven by energy prices, but may be more systemic.
A ‘hard political trade-off’
Anna Stupnytska, global macroeconomist at Fidelity International, said the ECB is facing a “tough political trade-off” that is more complex than that of other central banks in the developed market.
“On the one hand, it is clear that the current political stance in Europe, with interest rates still in negative territory and the balance still growing, is too light for the high level of inflation, which is becoming broader and more entrenched.” she said after Thursday’s decision.
“On the other hand, the euro area is facing a huge growth shock, driven at the same time by both the war in Ukraine and China’s activity due to the zero-COVID policy. High-frequency data already point to a strong hit for euro area activity in March-April. with consumer-related indicators worryingly weak. “
Fidelity International has a recession in Europe as a base scene, though Stupnytska said its seriousness and duration will depend on how further sanctions against Russia develop.
“As a full energy embargo becomes more likely, so is the worst-case recession scenario. We believe that as the growth shock becomes clearer in the data over the next few weeks, the ECB’s focus is likely to shift away from high inflation to try to limit economic and market distress as the invasion of Ukraine and its consequences continue to wave through the system, “she said.
“Unlike market prices, we do not expect the ECB to raise interest rates before Q4 this year or early 2023.”
Gurpreet Gill, macro strategist at Goldman Sachs Asset Management, said the next milestone in the ECB’s policy normalization agenda would be a decision on the pace of asset buying in the next quarter, which she suggested is likely to be the focus of the July meeting.
“With market-implicit prices already pointing to a rate hike in July and a total of three rate hikes this year, we see limited opportunity for any hawkish rhetoric to push prices higher,” Gill added.
Correction: This story has been updated to reflect the ECB’s confirmation that it will complete its third quarter bond purchase.
– CNBC’s Annette Weisbach contributed to this report.