Euro Area Monetary Policy June 2022

At its 9 June meeting, stuck between the rock of soaring inflation and the hard place of a worsening growth outlook, the European Central Bank (ECB) made no changes to its main monetary policy instruments. 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%. However, it announced the end of its era of unconventional monetary policy, with a 25 basis points hike to interest rates set to occur at its July meeting. It also confirmed that it will end net asset purchases under its asset purchase program (APP) in June. Moreover, it will end the special bank funding conditions applicable under TLTRO III on 23 June.

The move was in line with market expectations. Inflationary pressures have continued to intensify, as Russia’s invasion of Ukraine disrupts trade and supply chains, pushing up energy and commodity prices. Moreover, price rises have become more widespread as higher energy and production costs filter through to core consumer prices.

In the accompanying press conference, ECB Governor Christine Lagarde stated that risks to inflation remain skewed to the upside and include rising inflation expectations, possible second-round effects on wages, higher food and energy prices, and reduced production capacity. Economic momentum is being hit by the war in Ukraine, higher commodity prices and supply chain difficulties. Expansionary fiscal stances, accumulated savings, and healthy labor markets could be somewhat offsetting these drags on activity. Overall, the ECB sees inflation averaging 6.8% this year and 3.5% in 2023, while it forecasts GDP to expand 2.8% in the current year and 2.1% in the next.

The Bank’s guidance changed, as it stated that it “intends to raise the key ECB interest rates by 25 basis points at its July monetary policy meeting”, and to “raise the key ECB interest rates again in September”. It also left the door open to a 50 basis points hike in the latter meeting, although the decision will depend on the evolution of prices and the inflation outlook.

Commenting on the ECB’s decision, Carsten Brzeski, global head of macro at ING, noted:

“Today’s decision shows [the Bank has] managed to find a compromise between the doves and the hawks. A 50 basis point rate hike in July seemed to be fended off by opening the door for 50 basis point in September. The era of net asset purchases will come to an end in three weeks, and the era of negative interest rates will come to an end before the autumn. Simply put, the ECB just announced the end of a long era. Whether this will also be the start of a new era of continuously rising interest rates, however, is still far from certain.”

Almost a week later, the widening in bond spreads in the Southern European countries following the ECB meeting prompted the monetary institution to hold an emergency meeting, in an attempt to calm markets. At the end of the 15 June meeting, the Bank released a statement announcing that it will accelerate plans to create a “new anti-fragmentation instrument” and that it will “apply flexibility in reinvesting redemptions coming due in the PEPP portfolio”. Although the immediate reaction of the stock markets was positive, the effect was short-lived.

Brzeski also commented on the emergency meeting:

“An ad hoc meeting less than a week after an official meeting is a strong sign of emergency at the European Central Bank. ECB members, however, were not able to agree on any tangible action but tasked the so-called committees to speed up the work on an anti-fragmentation tool. All in all, this is not the first time that the ECB has been overtaken by market developments. The March 2020 experience should have been more prominent in the ECB’s institutional memory. Looking ahead, we still expect the ECB to hike interest rates by 25 basis point in July and 50 basis point in September with another 25 point hike in the winter.”

The next monetary policy meeting is scheduled for 21 July.

FocusEconomics Consensus Forecast panelists are still assessing the latest developments.