ECB: New anti-inflation tools are coming in from June

By Leonidas Stergiou

The aim of the head of the ECB, Mrs. Christine Lagarde, was to prepare the markets for the upcoming monetary policy changes. At the same time, he reassured saying that they will not be done abruptly, ie without countermeasures or without taking into account the side effects. He stressed many times that, in any case, he will use all the means at his disposal to contain inflation at 2% in the medium term.

The day after the announcements, that is, yesterday, the ECB published the forecasts of market analysts it requests every quarter in order to receive information on what investors believe. The data show a sharp deterioration in inflation, growth and employment forecasts, compared to those received a quarter ago. Thus, the day before yesterday’s announcements were a good opportunity to prepare the markets in view of the June meeting, when it will publish its own forecasts. In this way he covers the possibility of changing the “narrative” without looking credible.

Analysts’ forecasts have already been priced by the market and this reflects the yields on Eurozone government bonds. The yield curve shows the financing cost of the Eurozone economies rising by one to 1.75 percentage points from previous ECB announcements in December. In fact, the half increase took place from March to April.

Indirect interest rate increase

The increase in government bond yields is what ultimately affects and passes on the cost of financing the real economy. In this sense, increasing financing costs in markets that value inflation risk, the potential for interest rate hikes and the slowdown in growth do half the job of the ECB. Because market interest rates are rising without the ECB raising its own. In risk analysis, Ms Lagarde said in simple terms: “Either things will get worse in the face of war, so demand will fall, or inflation will get worse due to energy and external events, which will drive growth.” , hence the demand. In both cases, he said, reducing demand would reduce consumption and, consequently, growth, but also inflation.

Liquidity intervention

Another half of the ECB’s work on indirect interest rate hikes is as follows: As it announced, there is a possibility that the ECB will adjust the excessive liquidity limit of banks that does not bear negative interest rates. This actually means that less liquidity will bear interest with negative interest rates or, alternatively, the same liquidity will bear interest with less negative interest rates. This combination, ie the mechanism of acceptance of excess liquidity, which will be lower with negative interest rates, together with the already increased financing costs of the economy, is an indirect increase in interest rates.

Bond markets

Lagarde oracles do not end here. Comparing the same proposal, regarding the bond purchase program (APP), he said that the data received by the ECB show that the bond purchase program should be completed in the third quarter. He did not specify whether it was the beginning or the end of the third quarter. The timing is linked to the consideration for raising interest rates. Because any decision on interest rates will be made after the end of the APP program. And it will be taken “at some point”. “At some point” can mean from a week to a year …

New tool

Ms. Lagarde also prepared the market for the possibility of activating a tool, in the standards of the IMT (Outright Monetary Transactions) of the ESM (European Stability Mechanism), which will intervene in the bond markets to reduce the spread of side effects that may cause monetary policy decisions or changes in the macroeconomic environment. In the first phase, it seems that this will work by replacing government bonds that expire with bonds of countries in need of purchases from the ECB. It can do this until 2024 for Greece. But what can not be done without the activation of a new tool, such as OMT, is the simultaneous support of the bond market, by absorbing the liquidity that causes inflation.

OMT, which was invented from the time of Draghi and “whatever is needed”, concerns countries that are in a program of fiscal compliance (Memorandum) or increased supervision (such as Greece now until the summer). This tool could be modified accordingly, but this requires the consent of the Eurogroup, and especially Germany, which may threaten a veto. The ECB reportedly aims to either take control of the mechanism or set up its own counterpart.