With a focus on addressing significant inflation, the ECB opted to leave borrowing costs unchanged, refraining from any indication of potential rate reductions.
ECB President Christine Lagarde emphasized her confidence in an upcoming rebound in inflation and the persistence of robust price pressures. This stance sharply contrasted with the more dovish approach of her U.S. Federal Reserve counterpart, Jerome Powell, in a recent statement.
Lagarde stated, “We don’t think that it’s time to lower our guard,” emphasizing that there is still work to be done in the current economic climate, which can involve maintaining current interest rates. She clarified that the ECB policymakers did not discuss the possibility of rate cuts.
In a smaller policy shift, the ECB revealed plans to phase out its remaining bond-buying scheme, a remnant of measures taken during the COVID-19 pandemic. This change is not indicative of a dovish shift comparable to the U.S. Federal Reserve.
In November, euro zone inflation stood at 2.4%, with expectations of a modest rebound in the coming months due to tax adjustments and a lower basis of comparison from the previous year. Lagarde acknowledged that underlying price pressures were also showing signs of easing. However, she highlighted that domestic inflation, primarily driven by wage costs across the 20 euro zone countries, remained resilient, and the ECB needed to better understand this phenomenon.
While Lagarde hinted at a possible rate cut in the first half of the following year, she suggested that it would be more likely after June or July, given the wealth of upcoming economic data.
Traders only marginally adjusted their expectations of ECB rate cuts, with potential cuts now anticipated to start in April rather than March. These cuts could total nearly 150 basis points next year, compared to the previous expectation of up to 160 basis points before the ECB’s recent decision.
The ECB’s updated economic projections indicated lower inflation and growth forecasts, particularly for the next year. Despite these adjustments, Lagarde underscored that the forecasts were based on market conditions before the recent surge in expectations of ECB rate cuts.
This shift in market sentiment followed a lower-than-expected inflation reading for November and perceived dovish remarks from ECB board member Isabel Schnabel. The subsequent decline in bond yields has eased borrowing costs, potentially contributing to increased inflation.
The ECB has benefited from the rally in bond markets, allowing it to conclude its Pandemic Emergency Purchase Programme earlier than planned. Originally set to continue until the end of the following year, the ECB announced that it would only replace maturing bonds through June and phase out reinvestments in the second half of the year, reflecting a reduced need for stimulus measures in current market conditions.
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