ECB’s unpublished inflation estimate raises prospect of earlier rate hikes

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Updates from the European Central Bank

The European Central Bank expects to hit its elusive 2% inflation target by 2025, according to unpublished internal models that suggest it is on track to raise interest rates in just over two weeks. years.

It would be at least a year earlier than most economists expected the ECB to raise its deposit rate to a record low of minus 0.5%. Many analysts predict that benchmark rates in the 19 countries that share the euro will have remained negative for a decade since they fell below zero in 2014.

However, some investors are anticipating a rate hike by the end of 2023. This scenario appears to be confirmed by the ECB’s longer-term inflation outlook, which its chief economist Philip Lane discussed this week at a private call with economists at German banks, according to two people involved.

The internal forecast is expected to intensify the debate over how quickly the big central banks will cancel the massive stimulus packages they launched to counter the pandemic last year, and when they will start raising rates in response to the hike in inflation.

The ECB has struggled for several years to bring inflation back to its target and has consistently overestimated future price growth, which is the main factor in its decisions on setting interest rates and adjusting purchases of ‘assets.

ECB Chief Economist Philip Lane said this week he was confident of meeting the 2% inflation target © Alex Kraus / Bloomberg

While some analysts predict that the US Federal Reserve could start raising interest rates as early as next year if the economy continues to rebound from the pandemic, most of them expect the ECB to do so. do much later.

The BlackRock Investment Institute pushed back the point to which it expects the ECB to hike rates this week, saying: rates later this decade.

Inflation has skyrocketed this year around the world and in the eurozone, peaking at 3% in August. The ECB said this was due to “transient” factors and predicted price growth would come back below its target next year before reaching 1.5% in 2023.

The ECB only publishes economic forecasts for the next three years, updating them quarterly. But its collaborators are also developing a “medium-term baseline scenario”, which is projected in five years and is generally not made public.

Lane told German economists that this scenario shows inflation rebounding to 2% soon after the end of its three-year forecast period.

The ECB declined to comment prior to the publication of this story. After the publication, an ECB spokesperson told news services: “Mr Lane has not said in any conversation with analysts that the eurozone will hit 2% inflation soon after the horizon expires. ECB projection.

“The FT’s conclusion that an interest rate take-off could already occur in 2023 is not in line with our expectations. Mr Lane made it clear in a public event on Wednesday that by persisting with a high level of monetary stimulus, the ECB can meet its 2% target over time, without mentioning a specific date.

Line graph of the Eurozone deposit facility rate (%) showing Falling: How the ECB cut rates to an all-time high

In another online event later in the day, Lane said he was confident of meeting the 2% inflation target. “If you persist with a high level of monetary stimulus, you can do it,” he said. “We believe that the current set of [monetary policy] the instruments are working.

The ECB, which announced last week that it would slow down its asset purchases in response to improving financing conditions, recently adopted a new strategy, under which it set a triple lock on conditions before raise rates. Economists believe this made such a move less likely.

To raise rates, the ECB must predict that inflation will reach 2% within 18 months and stay there for another 18 months. At the same time, “core inflation”, which excludes volatile energy and food prices, must rise enough to be compatible with achieving the target. He also said he would tolerate a “moderate” exceeding of his target during a “transitional period”.

If the internal scenario that Lane leaked this week is correct, it means the ECB could qualify to start raising rates by the end of 2023.

Investors raised their medium-term inflation expectations in the euro area. The five-year and five-year swap rate recently rebounded well above pre-pandemic levels to just below 1.8%, its highest level in more than four years.

Line graph of the harmonized consumer price index (annual change in%) showing that the ECB expects inflation to fall

However, a former ECB official said her internal scenario should be “taken with a grain of salt” as it is only one ingredient in the complex process of formulating the official forecasts it publishes each quarter. “It’s a very political decision,” said the former official.

Frederik Ducrozet, strategist at Pictet Wealth Management, said Lane’s disclosure of the internal model could confuse investors if followed by a further increase in the ECB’s inflation forecast when its 2024 forecast is released in December. . “I think the bond market is stable for a reason, because it has visibility into ECB support,” he added.

Tommy Stubbington Additional Reports


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