December 1, 2023


The European Central Bank chose not to signal any meaningful change in its policy stance on Thursday despite record-high inflation and its own admission that prices could continue to rise.

The bank still plans to stop buying bonds sometime in the third quarter and start raising interest rates shortly after that, even though those interest rates are currently as much as eight percentage points below the rate of inflation.

By choosing not to act, the ECB increasingly stands apart from central banks in most of the rest of the world which have been taking more and more drastic steps in recent weeks to slam on the brakes.

This week alone, the central banks of Canada and New Zealand raised their key interest rates by a half-percent, while the U.S. Federal Reserve has been more and more open that it, too, will take that step at its next policy meeting in May.

The Frankfurt-based institution has reasons for taking a different course.

The eurozone economy is much more exposed to the war in Ukraine than any other region, even without further financial sanctions against Russia.

“While risks relating to the pandemic have declined, the war may have an even stronger effect on economic sentiment and could further worsen supply-side constraints,” ECB President Christine Lagarde said in the introductory statement to her regular press conference. “Persistently high energy costs, together with a loss of confidence, could drag down demand and restrain consumption and investment more than expected.”

But the insistence on keeping interest rates low is prompting increasingly frank calls for action, especially from Germany.

“The course of action for a central bank obliged to focus exclusively on price stability should be clear,” said Helmut Schleweis, head of the German Savings Bank Association. “To counter inflation with clear decisions and unambiguous communication.” 

The ECB’s stance also appears to be unsettling markets.

The euro fell as far as $1.0758, its lowest level against the dollar since May 2020, while the German government’s 30-year bond yield rose above 1 percent for the first time since 2018. Spreads to other countries’ bonds, which have widened in recent months as the ECB prepares to step away from supporting the bond market, were broadly stable.

Speaking from home, where she has been isolating due to positive tests for COVID-19, Lagarde acknowledged that the inflation picture had changed for the worse since the ECB’s last meeting.

Pictet Asset Management analyst Frederik Ducrozet took that admission as a hint that the ECB’s survey of professional forecasters — something the ECB uses to cross-check its own forecasting — “could be nasty” when it is published on Friday.

Even so, Lagarde rejected suggestions that the ECB was falling even further ‘behind the curve’ in its policy response and repeated what she said was the bank’s need to stay flexible.

Analysts say that “flexibility” for the next few months is ECB code for having a plan B in case the European Union abandons its current restraint and imposes a full embargo on Russian energy imports, which would have immediate and far-reaching effects on the region’s economy. (A committee of six German think tanks said earlier this week that such a step would cause the German economy to shrink by 6.5 percent over the next two years).

Lagarde said it’s “totally premature to speculate on when any such flexibility may be deployed,” and gave no details about a new tool that the bank is reportedly preparing as a defense against any fresh “fragmentation” of eurozone financial conditions along national lines.

“It seems the ‘anti-fragmentation program’ is not yet designed,” said Gilles Moec, group chief economist with AXA, via Twitter, “but the idea that it could act ‘promptly’ is a warning to those who want to push a spread widening trade.”

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