Inflation genie out of the bottle: Five questions for the ECB

LONDON (Oct 25) - The inflation genie is finally out of its bottle.

Now investors are waiting to see whether the European Central Bank on Thursday admits that price pressures are too significant to ignore. They will also want an explanation of what that means for its ultra-easy policy stance.

Big decisions on the future of the ECB’s pandemic emergency stimulus will wait until December. But with surging energy prices and supply bottlenecks, Thursday’s meeting should be anything but dull.

Here are five key questions on the radar for markets.

1/ What does high inflation mean for the policy outlook?

The ECB may acknowledge that a jump in price pressures is likely to last longer than anticipated, but the central bank is unlikely to abandon its dovish policy stance just yet.

Its 2023 inflation forecast is 1.5%, below the 2% target, and policymakers argue that tightening policy too early could hurt the economy.

ECB Chief Economist Philip Lane has argued that the current bout of inflation in the bloc is not a trigger for monetary policy action as growth in services prices and wages remains weak.

"They have to be very careful they don't scare the horses," said Craig Inches, head of rates at Royal London Asset Management. "If they come out a little bit on the hawkish side, certain peripheral markets could start to struggle." Graphic: ECB and markets,

2/ What about the mismatch between the ECB’s guidance and market pricing on interest rates?

Indeed, rate-hike expectations have shot up in recent weeks and markets are pricing in a 10 basis-point rate rise by the end of 2022.

This is out of sync with the ECB’s ultra-loose monetary policy stance and is a concern if higher market lending rates trigger tighter financial conditions.

The aggressive re-pricing is mostly a spillover from a sharp readjustment in Britain and the United States where investors are now expecting tighter policy. Lane has already pushed back against the market pricing; ECB chief Christine Lagarde may do the same on Thursday.

"We expect the ECB to remain dovish, while markets may continue to hedge against an earlier tightening by the ECB," said Societe Generale senior European economist Anatoli Annenkov. Graphic: Global money markets raise central bank rate hike bets  Global money markets raise central bank rate hike bets ,

Reuters