Five questions for the ECB

By Dhara Ranasinghe

LONDON, Jan 31 (Reuters) – Record euro zone inflation rates mean price pressures will top the agenda at the European Central Bank’s policymakers’ meeting on Thursday.

No immediate policy action is expected since the ECB presented its plans in December 2021-12-15 to end its €1.85 trillion ($2.09 trillion) pandemic stimulus package by the end of March.

But price pressures remain strong and markets want to know if the ECB is moving closer to a more hawkish stance. Here are five questions on the market radar.

1. Will the ECB change its language on inflation?

May be. The ECB has already slowly changed its language and may continue to do so.

ECB chief economist Philip Lane said last week that the ECB would tighten policy if inflation stayed above its 2% target, but such a scenario seems less likely for now. .

Eurozone inflation hit 5% in December, the highest on record, and is expected to fall back below target in the fourth quarter.

But some officials view that projection as overly optimistic. January data released the day before the ECB meeting could arm hawks with new ammunition to push for a change of tone – minutes from the December meeting revealed deep divisions on inflation.

2. Could a more hawkish Fed force the ECB to accelerate normalization?

Not likely. Lagarde believes that the ECB does not need to act as boldly as the US central bank given the different economic conditions. Labor markets, on the other hand, are much tighter in the United States.

“The euro zone is not the United States and there are no signs of domestic overheating,” said Katharine Neiss, chief economist for Europe at PGIM Fixed Income.

“But this is not a typical cycle, so there has to be a degree of humility and the ECB needs to be aware of the potential that the recovery could be stronger than it thought.”

A wave of rate hikes in the United States could complicate life for the ECB if the The Fed is ending its tightening cycle faster than in the past, giving the ECB a shorter window of action.

3. What does the ECB think of market prices for rate hikes?

Lagarde could push back on bets on higher market rates, which are out of step with the ECB’s ultra-loose monetary policy stance. Higher market lending rates could prove problematic if they lead to tighter financial conditions for businesses.

Money markets are pricing in a 10 basis point rate hike by October. Deutsche Bank estimates the ECB will begin with an aggressive 25 basis point hike in December.

But the ECB has essentially ruled out raising rates this year. It aims to gradually reduce its asset purchases, but it does not currently plan to stop them completely and it will not raise rates until it is finished buying bonds.

4. When does the ECB expect the second-round effects of inflation to appear?

With inflation higher for longer than expected and oil prices high, policymakers are making sure this doesn’t trigger higher wage demands, which in turn drive up price inflation.

Politicians point out that they do not see wages reacting significantly to inflation. The German government believes that the economic recovery and rising inflation will likely lead to “somewhat stronger wage growth” this year.

“The case for higher wages is extremely good, as we are seeing tighter labor markets in places like Germany and the Netherlands. The question is, will this be an isolated case?” said Piet Haines Christiansen, chief strategist, Danske Bank.

“Wages are the missing piece of the puzzle, and if we see inflation there, we will have a rate hike. And that could happen as early as the spring of next year.”

5. What is the impact of the evolving pandemic response on the macro picture?

Coronavirus variant Omicron has weighed on the economy, but with most countries avoiding full lockdowns, data suggests activity is holding up relatively well -bottlenecks-give-german-business-glimmer-hope-2022-01-25.

Lane said Omicron’s impact will be measured in weeks, not months.

For ECB watchers, signs that economic momentum is picking up mean that pressure to quickly remove stimulus measures could build. Uncertainties also cloud the outlook, such as how high oil prices and a slowdown in China could derail growth.

(Reporting by Dhara Ranasinghe; Additional reporting by Balazs Koranyi in Frankfurt; Editing by Tommy Wilkes and Hugh Lawson)

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