Guidance on ECB future direction awaits | Calamatta Cuschieri

On Thursday, European Central Bank (ECB) president Christine Lagarde who has thus far been adamant on the fact that inflation is largely due to transitory effects, is expected to push back against a growing belief amongst investors that interest rates may rise next year.

Inflation within the Euro area has over recent years largely revolved below the ECB’s inflation target of 2 per cent. That said, rising inflation – an important factor which may determine the need for an interest rate hike, is a relatively untouched territory. Notwithstanding the recent persistent rise in inflation, the Governing Council - the main decision-making body of the ECB responsible amongst other to formulate monetary policy for the euro area, is set to remain put.

The main focus of Thursday’s ECB meeting will be on what Lagarde says about the euro area’s inflation outlook and what will this outlook ultimately mean, in respect of interest rate decisions in the near term.

What’s causing inflation to prop-up?

The relaxation of coronavirus-inflicted movement restrictions, increased demand for goods - possibly also a result of a change in consumer trends, led to supply chain disruptions and labour shortages. A phenomenon we’ve been witnessing in 2021. Disruptions along with increased demand for goods led to higher input costs which were ultimately translated onto customers. This giving rise to the inflation proposition.

Albeit at times inflationary data proved to be a result of transitory moves, its persistence is seemingly lasting, raising concerns about policy makers’ narrative that recent price spikes are seen as temporary and that the economy requires low borrowing costs. A recent surge in energy prices added to inflation fears.

Temporary price pressures could well be embedded in more long-term expectations and last even as the growth from reopening fades away.

Euro area inflationary data points higher as energy prices surge

Eurozone inflation was confirmed at 3.4 per cent in September 2021, higher than August’s actual 3.0 per cent. The rate of expansion matches the highest rate of inflation since before the global financial crisis in September 2008 and substantially above the set 2 per cent target, raising concerns about the ECB’s narrative.

Energy prices are said to have been responsible for almost half of the overall year-on-year inflation reading, rising by 17.6 per cent in September following a 15.4 per cent increase in August. Additional upward pressure came from services and food, alcohol & tobacco. Meanwhile, costs for non-energy industrial goods rose at a slower pace.

Annual core inflation which excludes volatile prices of; energy, food, alcohol & tobacco, climbed to 1.9 per cent, the highest rate in over a decade.

ECB rate hike forecasted for 2024 – Reuters Poll

In anticipation of Thursday’s meeting, a Reuters poll of economists deduced that the ECB will be one of the last major central banks to raise rates following the coronavirus pandemic. The baseline forecast for the ECB is to “remain on hold through 2024”. The forecast is based on the assessment that inflationary data is indeed transitory and that the ECB will continue to see it as such.

We expect policy makers to continue with their plans to gradually unwind its stimulus programme. As things stand, the ECB has plenty of room to tighten policy, not just through raising interest rates but also through withdrawing quantitative easing. In September, we’ve seen the ECB taking its first step towards unwinding the emergency aid that has propped up the economy during the coronavirus pandemic. It announced a reduction in monthly emergency bond buying with the intention to end it completely in March 2022.

We believe that premature tightening, in respect to interest rates hikes, may however lead to quashing growth as the economy is recovering.

Disclaimer: This article was written by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. The article is issued by Calamatta Cuschieri Investment Services Ltd and is licensed to conduct investment services business under the Investments Services Act by the MFSA and is also registered as a Tied Insurance Intermediary under the Insurance Distribution Act 2018.

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