Euro Area: ECB scales back stimulus in December amid mounting inflationary pressures, but remains dovish

Euro Area Monetary Policy December 2021

Euro Area: ECB scales back stimulus in December amid mounting inflationary pressures, but remains dovish

At its meeting on 16 December, the European Central Bank (ECB) announced it will slow the pace of net purchases under the pandemic emergency purchase program (PEPP) in the first quarter of 2022 and discontinue them at the end of March. At the same time, in order to cushion the impact of reduced monetary stimulus, it will expand its asset purchase program (APP) from its current monthly pace of EUR 20 billion to EUR 40 billion in the second quarter of 2022 and to EUR 30 billion in Q3, before bringing it back to its current pace from October. Meanwhile, the ECB kept rates on the main refinancing operations, the marginal lending facility and the deposit facility at their respective all-time lows of 0.00%, 0.25% and minus 0.50%, thus holding a significantly expansionary monetary policy stance.

The decision was driven by surging inflationary pressures, despite a somewhat bleaker growth outlook for the currency area due to the expected spread of the Omicron variant. The ECB downgraded its growth projections for next year from 4.6% to 4.2%, and expects GDP to expand 2.9% in 2023. Moreover, it forecasts headline inflation to come in at 3.2% next year (previous forecast: 1.7%) and 1.8% in 2023. Additionally, President Lagarde stated that inflation could turn out to be higher if price pressures feed through to higher-than-anticipated wage rises. This, together with November’s headline inflation reading of 4.9%, was behind the Bank’s decision to tweak, albeit only to a limited extent, its crisis stimulus measures.

The Bank added that “it is very unlikely that we will raise interest rates in the year 2022”, although it subsequently added that it will have to “be very attentive to what data tells us, and we will do so at each and every monetary policy meeting”, suggesting that further stronger-than-expected inflation readings could force the Bank to resort to interest hikes earlier than currently expected.

Commenting on the latest decision and possible future moves, Carsten Brzeski, chief Eurozone economist at ING, noted:

“As long as the surge in inflation is mainly driven by one-off factors, often related to the pandemic, and so long as the ECB believes in this story, there is very little it can do to immediately curb inflation. No single ECB action would bring containers from Asia to Europe any faster, speed up the production of microchips, or lower energy prices. However, even if the ECB cannot directly stop inflation, it has definitely run out of arguments for continuing with all emergency measures and ultra-loose monetary policy as if nothing had happened. Today’s cautious taper is only a logical consequence. […] Don’t forget that it was only three months ago that ECB president Christine Lagarde said that “the lady is not tapering”. It is a cautious taper for now but we think that rate hike speculation will emerge much earlier than she or the wider European Central Bank might like.”

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