ECB Meets With Fresh Inflation Shock to Ponder: Decision Guide

(Bloomberg) -- Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.

The European Central Bank is set to decide how to respond to an unprecedented inflation shock that's prompted traders to ramp up bets on interest rates being lifted this year.

Data released as the Governing Council's two-day meeting began on Wednesday showed consumer prices unexpectedly surged by a record 5.1% in January. That's more than double the 2% target, overshooting analysts' expectations by the most in at least two decades.

While the surprise isn't expected to trigger an immediate policy response from the central bank, it's left many wondering whether President Christine Lagarde will follow the likes of Federal Reserve Chair Jerome Powell in backing away from the idea that elevated inflation will pass without firmer action.

So far, Lagarde has insisted a rate hike is unlikely this year -- despite the Fed gearing up for several of its own and the Bank of England lifting borrowing costs for a second straight meeting on Thursday.

Money markets are skeptical. They predict a 10 basis-point increase from the ECB by September and on Wednesday briefly brought that forward to July. They see a total of 25 basis points of tightening by year-end, bringing the deposit rate to minus 0.25%.

Follow our live blog on the ECB rate decision 

The focus for investors will be whether Lagarde reveals any signs of hawkishness. Her news conference will take place 45 minutes after the ECB's decision at 1:45 p.m. Frankfurt time.

What Bloomberg Economics Says...

“The ECB stands alone in keeping rates at rock bottom while inflation breaks records. With the Federal Reserve and the Bank of England taking a different path, anxiety about falling behind the curve is growing, lowering the bar for action.”

--Jamie Rush, chief European economist. Read the full note here. 

Officials will also discuss the broader economic outlook. Supply disruptions and the spread of the coronavirus's omicron strain kept euro-area growth to just 0.3% in the final quarter of 2021, while a sharp contraction has left Germany on the brink of a second recession since the pandemic began.

Euro-zone expansion eased further at the start of 2022, according to IHS Markit.

“Having receded slightly at the end of last year, January survey data revealed a re-acceleration of inflation across the euro area,” it said Thursday.

An escalation in the standoff between the West and Russia over Ukraine, meanwhile, risks further crimping output and stoking prices if energy supplies are hampered.

As announced at the last meeting, net bond-buying under the ECB's 1.85 trillion-euro ($2.1 trillion) emergency program will end as scheduled in March, while regular purchases will increase for six months to smooth the transition. 

Bringing forward rate increases would shift this timetable as per current guidance that calls for bond-buying to be wound down “shortly” before any rise in borrowing costs.

At present, ECB officials say this probably won't be necessary, pointing to a medium-term outlook where inflation falls short of the goal.

While any significant policy changes aren't likely before those projections are reviewed in March, this week's reading has Commerzbank economist Christoph Weil saying Lagarde may not repeat her line that a hike is unlikely in 2022.

Despite the tightening of monetary policy in other Western economies leaving the ECB as something of an outlier, Lagarde says Europe is in a different position to the U.S., where inflation is faster and the recovery more advanced.

©2022 Bloomberg L.P.