The ECB claims that the Ukraine conflict is driving up prices, but it intends to respond gradually.
There is no set date for rate rises, which sends the euro down to a two-year low as policymakers try to figure out how to deal with both inflation and growth risks.
The Ukraine crisis is driving prices higher and wreaking havoc on the eurozone economy more than in most other places, European Central Bank President Christine Lagarde said on Thursday, as the bank maintained its gradual withdrawal of monetary assistance.
Certain investors had anticipated the ECB to go farther by accelerating the end of net bond purchases and boosting interest rates. The euro dropped to its lowest level against the dollar since May 2020 when it announced the continuance of its objectives.
The central bank's governing council members, who convened this week in Frankfurt, are debating how aggressively to tighten monetary policy in order to combat record inflation while also weighing the danger of a rapid economic slowdown induced by Russia's invasion of Ukraine.
“The upside risks surrounding the inflation outlook have also intensified, especially in the near term,” said Lagarde, who joined the meeting by video link after testing positive last week for Covid-19.
Lagarde said that following the eurozone's new inflation record of 7.5 percent in March, several financial market analysts and specialists increased their longer-term price rise estimates over the ECB's 2% objective.
“The last thing that we want to see is the risk of a de-anchoring of inflation expectations ,” she added.
She also said the “downside risks to the growth outlook have increased substantially as a result of the war in Ukraine”. The “euro area is probably going to be more exposed and will suffer more consequences from the war in Ukraine” than the US or other regions, she said.
Athanasios Vamvakidis, head of foreign exchange strategy at Bank of America, said investors had hoped for “something more specific” on when ECB would stop buying more bonds and start raising rates. “On both counts there was nothing new,” he said. “It’s not that Lagarde was dovish exactly, she just wasn’t as hawkish as the market — particularly the forex market — was expecting.”
Analysts trimmed their bets on the chances of a July rate rise when the ECB president declined to be drawn on timing. The single currency fell more than 1 per cent to $1.076 against the US dollar, the lowest for two years.
“With the ECB more concerned with the inflation outlook than growth, it will continue to use the current window of opportunity to normalise monetary policy,” said Konstantin Veit, portfolio manager at asset manager Pimco, predicting it would stop net asset purchases in July and raise rates by 0.25 per cent in September. “We’ll deal with interest rates when we get there,” Lagarde said, emphasising that increasing price pressures had “reinforced” the council’s expectation that net bond buying would stop in the third quarter.
Her remarks set the stage for the ECB's June meeting, when it will determine precisely when to stop adding to its €4.9 trillion bond portfolio and release updated predictions on the impact of the Ukraine war on inflation and economy.
According to Katharine Neiss, chief European economist at PGIM Fixed Income, the announcement "indicates that the door is now wide open for rate hikes later this year," but given the risk to growth posed by the Ukraine war, "the debate among the governing council will likely shift away from when to begin raising rates and toward when to stop."
Markets are pricing in a return of the ECB's deposit rate above zero by the end of the year and to about 1.5 percent by the end of next year. However, the central bank stated that any rate hike would be "gradual" and would occur "some time" after the central bank ceases net bond purchases.
Lagarde was asked if the ECB was developing a "new tool" to offset a potential sell-off in specific nations' bonds. However, she emphasized the need of flexibility, stating that it has demonstrated the ability to develop new tools "in a flash," such as in reaction to the epidemic.
Numerous other central banks have ceased bond purchases and begun hiking interest rates. The Reserve Bank of New Zealand and the Bank of Canada both increased interest rates by a half-point this week, while South Korea and Singapore also tightened policy.