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Post: Market Extra: European Central Bank’s Lagarde won’t rule out 2022 rate hike as inflation risks ’tilt to upside’

European Central Bank President Christine Lagarde, who previously deemed a 2022 interest rate increase unlikely, refused to take that prospect off the table Thursday as she acknowledged that inflation pressures in the eurozone are now “tilted to the upside.”

Lagarde emphasized that policy makers wouldn’t rush into a decision, but signaled that the ECB’s next policy meeting in March will entail a detailed assessment of inflation pressures and the potential response. That could set the stage for an interest rate increase later this year, economists said, though market participants may still be overly aggressive in pricing in potential moves.

Lagarde said there was “unanimous concern” among policy makers at Thursday’s meeting over inflationary pressures and their effect on consumers. “The situation has indeed changed,” she said, but also emphasized that rising energy prices account for at least half of the price rises and that while inflation is expected to remain hotter than expected in the first quarter, it’s likely to come down over the course of 2022.

A 5.1% eurozone annual inflation reading for January was much higher than the ECB expected back in December, when staff forecast inflation to average 4.1% in the first quarter, noted Andrew Kenningham, chief Europe economist at Capital Economics, in a note.

“We will assess very carefully, we will be data dependent, we will do that work in March,” Lagarde said. The ECB chief, pressed on whether she was sticking with her assertion late last year that rate increases in 2022 were unlikely, instead emphasized that such pronouncements always come with conditions.

At the same time, she emphasized that the ECB would proceed in line with its forward guidance “and that we will continue to observe the sequence that we have agreed” to follow. The ECB, in its forward guidance, has said a rate increase will come after it has wound down asset purchases.

The euro

jumped 0.9% versus the U.S. dollar to trade at a two-week high near $1.1404. The shared currency has been under pressure since the beginning of the year as the U.S. Federal Reserve adopted a more hawkish tone on rates.

Money-market funds briefly showed traders pricing in a 10 basis point move in June, which economists dismissed as unlikely given the ECB’s timetable for adjusting asset purchases. But expectations for a move by December no longer seem wildly out of line.

In a policy statement, the ECB affirmed its December announcement that asset buying under its Pandemic Emergency Purchase Program, or PEPP, would proceed at a slower pace in the first quarter and be discontinued at the end of March, while activity under its separate Asset Purchase Program would be boosted from 20 billion euros a month to 40 billion euros in the first quarter and would run at 30 billion euros a month in the second quarter, returning to 20 billion euros in the third quarter.

Lagarde, however, “opened the door to a speeding up of asset purchase reductions and a rate hike this year,” said Carsten Brzeski, global head of macro at ING, who described the central bank’s shift as a “remarkable hawkish roll.”

“Taking all this into consideration and assuming that energy prices do not dive over the next four weeks, we expect the ECB to speed up the reduction of net asset purchases and to bring them to an end in September, allowing the ECB to hike the deposit rate at least once before the end of the year,” he said, in a note.

Skeptics continue to doubt prospects of a rate increase by year-end, but acknowledged that the ECB appeared to be setting the stage for a quicker winddown of its quantitative easing program that could pave the way for a rate increase in the fourth quarter.

“At this point, we see little reason to believe that the numbers will offer any relief over the next few weeks before the cut off [for] the March forecasts” by ECB staff, said Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, in a note.

“That said, we still doubt the ECB will go in Q4. We are now inclined to look for the first hike in January 2023, by 20bp, with 10bp in March and June, respectively,” he said.

The Bank of England earlier on Thursday delivered a second rate increase, while the Federal Reserve has signaled it will begin what’s expected to be a series of rate increases in March.

See: Bank of England makes consecutive interest rate increases for first time since 2004

European government bond yields jumped. The rate on the 10-year German government bond
which recently returned to positive territory in response to rising inflation readings, jumped 9.8 basis points Thursday to 0.14%.

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