ECB sticks to gradual stimulus exit as bets on hikes build

[FRANKFURT] The European Central Bank renewed its pledge to withdraw pandemic stimulus only gradually, even after a record inflation reading fed market expectations for a first interest-rate hike in more than a decade this year.

A day after data showed the steepest euro-area price gains on record - defying predictions for a lessened pace - the Governing Council on Thursday reiterated that it will slow bond-buying across 2022 and end asset purchases entirely before raising borrowing costs.

As expected, the ECB kept the rate on its main refinancing operations at zero, its marginal lending facility at 0.25 per cent and its bank deposit rate at negative 0.5 per cent, according to a statement.

Affirming the plan underscores the widening divergence with the more aggressive monetary-policy tightening under way in the US and the UK. On Thursday, the Bank of England lifted rates by a quarter point for a second straight meeting, in a close-run decision where four officials had sought an even bigger increase.

The ECB position also signals that policy makers in Frankfurt are sticking to their guns on elevated inflation abating once energy costs and supply-chain snarls ease.

Prices jumped 5.1 per cent last month - more than double the 2 per cent target. While President Christine Lagarde insists a rate hike is unlikely this year, money markets are increasingly skeptical. They predict a 10 basis-point increase from the ECB by September and on Wednesday briefly brought that forward to July. They now see almost 30 basis points of tightening by year end. The euro declined and German bonds pared losses after the decision.

"Market participants are likely to focus in February on the Governing Council's risk assessment, with the language on inflation grabbing the most attention," said David Powell, senior euro-area economist.

A key question for the ECB chief is how the institution's latest projections stand up in light of this week's data shock. Just two months ago, officials predicted inflation would return to 1.8 per cent in 2023 and 2024.

Any upward revision could mean the conditions for a rate hike are close to being met and may force policy makers to rethink their plans. New ECB projections are due in March.

Record Covid-19 infections and persistent shortages of manufacturing components continue to provide headwinds, while an escalation in the standoff between the West and Russia over Ukraine risks holding back the recovery and stoking prices if energy supplies are hampered.

The euro-area economy isn't starting 2022 on a strong footing, expanding by just 0.3 per cent in the final quarter of last year. Germany, meanwhile, is on the brink of a second recession since the pandemic began after a surprisingly sharp contraction. BLOOMBERG