ECB surprises markets with faster than expected winding-down of quantitative easing

The European Central Bank sprang a surprise on markets today.

The bank, to nobody’s great surprise, kept interest rates unchanged.

Its main policy rate, the so-called deposit facility, remains at -0.5%.

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But the ECB, the first of the world’s major central banks to make a policy decision since Russia’s invasion of Ukraine, did nonetheless come up with some unexpected news.

The bank said that, as planned, it would discontinue net purchases under its €1.85trn Pandemic Emergency Purchase Programme (PEPP) at the end of the month.


However, in a clearly more hawkish tack, it also announced that net purchases under its Asset Purchase Programme (APP) will come to an end at some point between July and September this year.

It will also taper away its remaining purchases more rapidly.

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This represents a faster winding down of its asset purchases – quantitative easing in the jargon – than expected.

Crucially, the ECB also changed the wording in its policy announcement, dropping a previous reference to possibly taking its main interest rate further into negative territory if required.

Image: The ECB targets inflation at 2%

That was taken as a possible hint that its first interest rate rise since July 2011 could now come earlier than expected.

Economists were not expecting the ECB to raise interest rates until the end of the year at the earliest.

The euro briefly spiked on the foreign exchange markets as the news emerged, hitting its highest level against the pound for a month, while the single currency also hit its highest level in a week against the US dollar and the Swiss franc.

Stocks in the eurozone, which had been falling all morning, extended their declines.

Eurozone government bonds, particularly those of Italy, sold off.

The move is probably as much as the ECB could do.

The central bank found itself in an exceptionally difficult position going into this meeting – on the one hand remaining wary of the uncertainty created by Russia’s war on Ukraine, but on the other remaining mindful of the fact that inflation in the eurozone was at a record high of 5.8%, even before Vladimir Putin launched his invasion.

In some eurozone economies, inflation – which the ECB is mandated to keep at 2% – is running at even more than that.

Image: The pound initially fell sharply versus the euro

Seema Shah, chief strategist at Principal Global Investors, said: “Despite the severe deterioration in the euro area’s economic outlook, the ECB retained a more hawkish tone in their statement.

“A faster winding down of the asset purchase programme will perhaps come as a surprise to market participants who expected an ECB capitulation in the face of weaker growth forecasts.

“Yet, with inflation still drastically above their target, it is important that the ECB retains an air of unwavering commitment to price stability.

“However, make no mistake, if the conflict is prolonged and elevated energy prices weigh heavily on household consumptions and confidence, the ECB will find it immensely tough to raise rates this year.

“Who would want to be a central banker in this situation?”

Anna Stupnytska, global macro economist at Fidelity International, said: “While the March meeting is too early for a policy change, the overall tone came in hawkish as ECB continued to signal wind-down of the QE programme in the third quarter of this year and dropped references to lower rates if needed despite the sharp rise in economic uncertainty.

“We think as the growth shock becomes more evident in the data over the next few weeks, the ECB’s focus will likely shift away from high inflation focus towards trying to limit economic and market distress as the invasion of Ukraine and its consequences ripple through the system.

“We do not expect the ECB to hike rates this year, despite change in market pricing towards October in the aftermath of the statement, and we believe the risk is skewed towards more QE, not less especially if gas supplies from Russia to Europe are disrupted going forward.”

Image: Ms Lagarde said the war would mean higher food costs

There was little in the ECB’s statement on the war in Ukraine other than this line: “The Russian invasion of Ukraine is a watershed for Europe.

“The [ECB’s] governing council expresses its full support to the people of Ukraine.

“It will ensure smooth liquidity conditions and implement the sanctions decided by the European Union and European governments.

“The governing council will take whatever action is needed to fulfil the ECB’s mandate to pursue price stability and to safeguard financial stability.”

But the bank has cut its growth forecasts for the eurozone as a result of the war.

It is now expecting growth of 3.7% during 2022, down from its previous forecast of 4.2%, while the ECB also cut its growth forecast for next year from 2.9% to 2.8%.

It left its forecast for 2024 unchanged at 1.6%.

The bank has also upped its forecasts for inflation.

Image: Energy costs have risen further in recent weeks, Ms Lagarde said

This is now expected to be at 5.1% by the end of the year, compared with the previous forecast of 3.2%, while it expects inflation next year to come in at 2.1% – up from 1.8% previously.

The ECB’s president, Christine Lagarde, said the downgrade for growth expectations this year was due to the invasion of Ukraine.

She added: “Energy costs have risen further in recent weeks and there will be higher food costs as a result of the war.

“Energy prices will stay high for longer than previously expected.”

But she said labour markets continued to improve in the eurozone, with the jobless rate falling to 6.8% in January, while wage growth remained “muted” – although this is expected to pick up during the year.

She went on: “The risks to the economic outlook have increased substantially due to the invasion.

“The war in Ukraine…could worsen supply side constraints again.

“The Russian invasion of Ukraine has caused substantial volatility in financial markets.”

Ms Lagarde stressed, though, there was little risk of the war sparking another financial crisis.

She pointed out that the banking system in the eurozone remained well capitalised and said lending to households, especially for house purchases, had held up.

The main takeaway is that, while the ECB expects the war in Ukraine to hurt growth this year and create yet more uncertainty for the eurozone economy, it is rather more worried about the recent take off in inflation.