Doha [Qatar], May 1: The European Central Bank left interest rates unchanged as expected on Thursday while signaling rising concerns over soaring inflation, leaving markets expecting it to lift rates several times this year with a likely initial move coming in June. Inflation jumped to 3 percent this month, well above the bank's 2 percent target, and a further rise is expected as the Iran war has pushed oil prices to a four-year high. ECB President Christine Lagarde said the final decision to hold rates was unanimous but told a press conference a possible rate hike had been discussed "at length" by policymakers.
"We made an informed decision based on as-yet insufficient information," she said, adding that their next meeting in June would be the "right time" for a new assessment.
"There is such uncertainty that we need to understand and revisit that at our next policy meeting," she said. "We are certainly moving away from our baseline," she said of a scenario built around an early end to the war and a limited energy shock.
Earlier, the ECB said in a statement that upside risks to inflation and downside risks to growth had both intensified. "The longer the war continues and the longer energy prices remain high, the stronger is the likely impact on broader inflation and the economy," it said.
Money markets priced in around 72 bps of ECB hikes by year-end, down from 76 bps earlier in the session. The euro fell very slightly after the ECB's decision, but was last up 0.2 percent at $1.17.
The ECB said longer-term inflation expectations remained well-anchored even as inflation expectations over shorter horizons have moved up significantly.
Still, any rate hike cycle is likely to be more benign than in 2022, when the ECB had to lift its key rate by a combined 450 basis points in the span of a year to arrest runaway price growth. Price pressures are far weaker now, the second-round inflation effects are not yet visible, the labor market is softer, rates are already higher to begin with, and economic growth is close to stalling.
Indeed, the eurozone economy barely grew in the first quarter, even before the war had any meaningful impact. Meanwhile underlying or core inflation, a key component scrutinized to gauge the durability of price growth, actually slowed to 2.2 percent in April from 2.3 percent, suggesting that second-round effects are not taking hold in a meaningful way. This means the ECB must tread carefully.
Some economists think the energy shock itself could cut as much as 0.5 percentage point off economic growth - roughly half of the bloc's projected expansion in the coming year.
The second quarter is already looking dismal due to the war, and the bloc's biggest economy, Germany, could even contract.
All that said, Lagarde said the notion of "stagflation" did not apply to current circumstances. "That is a term better to be parked in the 1970s," she said in response to a question.
Surveys this week showed business sentiment is plunging quicker than predicted, the services sector is deteriorating, corporate profits are dropping, exports are still reeling from tariffs, and banks plan to curtail firms' access to credit. But central bankers around the globe have argued that six weeks make little difference in rate hikes, so it is worth waiting a bit longer to gain more certainty over price trends.
The Bank of Japan, the US Federal Reserve, the Bank of Canada and the Bank of England all also left rates unchanged this week, even while expressing concerns over price growth. But the "memory effect" of having lived through rapid inflation just a few years ago may work against central banks.
It was the first big inflation shock in decades, so consumers may respond quicker this time, especially after workers took a large real-terms wage cut from the 2021/2022 episode. "The experience of inflation is so recent that businesses will raise prices sooner than in 2022, and even workers will try to secure higher wages sooner, which will likely accelerate inflation developments," said Lorenzo Codogno of LC Macro Advisors.
Source: Qatar Tribune
