ECB raises inflation forecast but sticks to bond-buying plan

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The European Central Bank will maintain the pace of its bond purchases in the coming weeks, it said on Thursday, despite increasing its forecasts for eurozone growth and inflation.

The Frankfurt-based institution resisted calls from some policymakers to start reining in its monetary stimulus as the eurozone economy recovers from the impact of the coronavirus pandemic, and kept its main policy measures unchanged.

The central bank said bond purchases under the €1.85tn pandemic emergency purchase programme (PEPP) — its main crisis-fighting policy — would continue in the three months to September at “a significantly higher pace than during the first months of the year”.

In a press conference, ECB president Christine Lagarde said that although the economy was “gradually reopening” and inflation was expected to continue rising this year, the central bank expected price growth to fade again next year.

She added that there was still “significant economic slack that will only be absorbed gradually over the projection horizon” and any tightening of monetary policy would be “premature” at this stage as it would threaten the recovery and the outlook for inflation.

Coronavirus infection levels are falling and lockdowns are being lifted across Europe. In addition, the pace of vaccinations is accelerating after a slow start.

Business activity, consumer confidence and inflation have all bounced back strongly in recent weeks. The headline rate of price growth hit 2 per cent in May, topping the ECB’s target of close to, but below, 2 per cent.

But Lagarde said it was “too early” to discuss scaling back bond purchases. The ECB has just over €700bn of the overall €1.85tn left to spend in the PEPP, which is due to last until at least March 2022.

“Central banks are happy to be behind the curve at this juncture,” said Henrietta Pacquement, a European credit portfolio manager at Wells Fargo Asset Management. “Manufacturing in Europe is doing better and services are expected to improve, but I think the ECB will want to see more evidence of recovery before they act.”

The central bank raised its forecast for the harmonised index of consumer prices in the eurozone this year from 1.5 per cent to 1.9 per cent, in line with its target. But it said HICP would fall to 1.4 per cent in 2023 as energy price rises faded. Excluding more volatile energy and food prices, core inflation is expected to rise from 1.1 per cent this year to 1.4 per cent in 2023.

Lagarde said core inflation was “still far away” from the ECB’s target and “certainly not where we would like to be once the pandemic is over” so it decided to keep “a steady hand” on policy. But she noted a “slight movement upward” in underlying price growth that it will “continue to monitor closely”.

The ECB also raised its forecast for euro area economic growth this year to 4.6 per cent and for next year to 4.7 per cent, while keeping its 2023 forecast unchanged at 2.1 per cent. It switched from saying the risks were “tilted to the downside” in the short term to describing them as “balanced” for the first time since the end of 2018.

Frederik Ducrozet, strategist at Pictet Wealth Management, said the higher forecasts and upgraded risk outlook “paves the way for a tapering by the ECB in September”. But he added that “the bigger decision” would be how many bonds the ECB continues to buy after PEPP ends next year, a question which is unlikely to be resolved until December.

Some of the ECB’s more conservative hawks had called for a slowdown in bond buying and Lagarde said there were “a couple of diverging views” on the decision despite “broad agreement” among council members.

“This is a win for the ECB doves,” said Krishna Guha, vice-president at Evercore ISI. “We think the council was leaning towards slowing PEPP in June early in the inter-meeting period, but got cold feet after the market moved to push nominal yields sharply higher with periphery spreads, the euro and rate hike expectations also moving too much for comfort.”