Christine Lagarde has spent several days persuading investors the European Central Bank will take a more “gradual” approach than the Federal Reserve to stamping out soaring inflation.
However, her insistence that the eurozone economy is not yet as strong as the US has not stopped markets pricing in the possibility of the ECB raising rates for the first time in a decade as soon as July.
Such a shift, which analysts at Goldman Sachs and JPMorgan Chase are now forecasting, would mark a turnround for the ECB and its president, who was insisting as recently as December that it was “very unlikely” to raise rates at all in 2022.
Markets now bet the ECB will take its deposit rate from minus 0.5 per cent into positive territory by the end of this year and to above 1 per cent next year.
Even so, the ECB will still lag far behind the Fed, which last month raised rates by a quarter of a percentage point from close to zero and is expected to announce a half-point rate rise at its policy meeting next week.
Jay Powell, Fed chair, has hinted at a string of half-point rises to swiftly bring rates to a “neutral” level that no longer actively stimulates demand. Analysts put the neutral rate at between 2.25 and 2.5 per cent.
The Fed will also begin shrinking its $9tn balance sheet as early as June — something the ECB is not planning to do before the end of 2024 at the earliest.
At first glance, the ECB seems to have almost as big an inflation problem as the Fed. Eurozone consumer prices rose by a record 7.4 per cent in the year to March — nearly as far above the 2 per cent level targeted by most central banks as the 8.5 per cent rise reported by the US.
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But Lagarde told CBS on Sunday there were several reasons why the ECB was “facing a very different beast” to the Fed, especially the war in Ukraine. Moscow’s invasion has left Europe more exposed to soaring energy costs because of the region’s greater reliance on Russian oil and gas imports.
Higher energy prices account for half of eurozone inflation, much more than in the US, Lagarde said, adding: “If I raise interest rates today, it is not going to bring the price of energy down.”
Core inflation, stripping out more volatile energy and food prices, was 2.9 per cent, less than half the US level of 6.5 per cent. Lagarde also pointed out that labour markets on the other side of the Atlantic were “incredibly tense” compared with those in Europe.
US private sector average hourly earnings were 5.6 per cent higher in March than the previous year. By contrast, annualised labour cost growth in the eurozone has remained sluggish and even slowed to 1.9 per cent in the fourth quarter, down from 2.3 per cent in the previous quarter.
Lagarde said these factors, along with fears the war in Ukraine will hit Europe’s economy harder than most regions, meant the ECB aimed to shift policy in “a sufficiently well sequenced, well calibrated, and — for us in Europe — a gradual way, so that we don’t induce recession”.
The ECB said earlier this month it expected to stop adding to its bond portfolio in the third quarter. Lagarde went further on Sunday by saying there was a “high probability we do so early in the third quarter and then we will look at interest rates and how and by how much we hike them”. That leaves open the possibility of raising rates at the governing council’s meeting on July 21.
Frederik Ducrozet, a strategist at Pictet Wealth Management, said: “The hawks are pushing for a July rate rise, which is not crazy at this time. I can see it happening even if it is not the base case.”
Lagarde said the timing of tightening would be “data-dependent”. Analysts said recent business surveys, such as the S&P Global purchasing managers’ index and the Ifo Institute’s index of German business confidence, showed the eurozone had weathered the fallout of the war better than expected — boosting the likelihood of a July rise.
“There has been a deterioration of growth, particularly in manufacturing,” said Silvia Ardagna, chief European economist at Barclays. “But we’ve had a much stronger services sector thanks to the reopening of the economy after Covid.”
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First-quarter gross domestic product figures for the eurozone are likely to back this up when released on Friday. They are expected to show resilient growth of 0.3 per cent from the previous quarter. Eurozone inflation, due on the same day, is set to fall slightly due to lower energy prices — but analysts expect a continued rise in core inflation to keep up the pressure on the ECB to tighten policy.
A concern for the ECB will be that the last few times it raised rates — in 2008 and 2011 — were shortly before eurozone recessions.
Some worry it could repeat the mistake again. “All in all, the slowdown is inevitable,” said Jens Eisenschmidt, chief European economist at Morgan Stanley who used to work for the ECB. “We assume an EU oil embargo on Russia in some form this year and then we are not that far away from a technical recession in the second half of the year.”
Source: Economy - ft.com
