ECB: Inflation, higher gas prices and monetary policy balance

In an environment where central banks approach monetary policy from opposing perspectives, the European Central Bank (ECB)’s statements and updates tomorrow may indicate an important turning point. The Bank will update its macro forecasts, especially inflation, at its June policy meeting. The fact that will come to the fore more than the updates to the projections will be a possible signal that the interest rates will increase in July.

We observe that a broad market consensus is emerging for the ECB’s first rate hike to take place in July. Lagarde’s comments on the possibility of a 50 basis point rate hike instead of 25 basis points at the press conference will be watched closely. In assumptions about the ECB, OIS pricing highlights the possibility of a cumulative 125 basis point increase, while market assumptions focus on 50 basis points increases in July and September. It will be important whether Lagarde’s statements refer to the 50 basis point increase or where the interest rate bar is drawn. We are focusing on the possibility of interest rate hikes in July, September and December and every quarter thereafter until the main refinancing rate reaches 1.5%, which is generally assumed to be neutral, and we will look for the possibility of one or two of these being 50 bps instead of 25.

June will be the last month of net bond purchases through the Asset Purchase Programme. Interest rates for targeted long-term refinancing operations are also expected to increase by 50 basis points in June, as the need for cheaper funding will soon disappear.

ECB interest rate projections OIS pricing… Source: Bloomberg

Eurozone activity and the inflation outlook have become very uncertain due to Russia’s war in Ukraine. The war in Ukraine has led to a further rise in energy prices, which will keep headline inflation very high in the months ahead. After this, inflation is expected to decline towards the target in the future. The main difference from the energy assumptions used by the European Central Bank in March is that financial markets predict natural gas prices to remain higher next year as the EU phases out Russian gas and is dependent on more expensive energy sources. At the March meeting, ECB projections had set inflation as 5.1% in 2022, 2.1% in 2023 and 1.9% in 2024. The ECB’s inflation forecasts will be revised significantly upwards this year, with a higher and possibly a later peak. Despite the projections to be moved up for the short-term, revisions to the medium-term inflation outlook are likely to be more limited.

The growth outlook weakened and became more uncertain as the war pushed up energy prices, eroded confidence and affected trade. Still, assumptions remained at the March 2022 meeting that the economy would continue to grow as the reopening continued. According to previous projections, real GDP is expected to grow by 3.7% in 2022, 2.8% in 2023 and 1.6% in 2024. The near-term projection of GDP growth will likely be lowered further.

The balance of parameters such as inflation, growth rate, primary surplus in determining the monetary policy puts the nature of the steps to be taken due to the Fed/ECB divergences in a critical balance. Along with the course of the central bank against inflation and the economic effects of the Ukraine war, we will highlight the different balances of countries such as Germany and Italy.

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