The ECB statement, which opened with support for the Ukrainian people, contains some unexpected details regarding the progress of the bond buying program. Although Russia's invasion of Ukraine is an important turning point, we see that the ECB's concerns about staying behind the inflation curve will shape the future of the bond buying program, as the statements centered on price stability. The change in interest-related wording in the policy statement and asset purchases (this time within the APP) that will likely end before the end of the year show this path.

 

If we look at the content of the ECB policy text;

 

·        The Governing Council will take any action necessary to fulfill the ECB's mandate to maintain price stability and maintain financial stability.

·        The Governing Council will make net purchases under the APP in the third quarter.

·        Any adjustments to ECB interest rates will occur some time after the Governing Council's net purchases under the APP expire and will be gradual.

 

The ECB decided to cut its bond purchases to 30 billion euros ($33 billion) in May, then to 20 billion euros in June. Authorities may decide to discontinue the program in the third quarter. In this context, progress continues in terms of ending extraordinary incentives. With inflation reaching 5.8%, it is almost three times the official target. The continuation of the rise in oil prices in an environment of ongoing war will make it more difficult to protect the anchor, and the continuation of the support puts the inflation outlook into a dilemma. However, the most important detail of the contradiction of this decision with economist expectations comes from the point of economic growth. Eurozone industrial production will slow down due to supply network problems due to the war, which will drag current economic growth down from 2Q22. Inflation is no longer the only risk, it has changed dimensions and turned into stagflation risk.

 

The continuation of negative interest rates has left the ECB at a point where it is struggling to maintain its anchor as inflation risks increase in the aftermath of the pandemic. Deposit rates, which remained negative for a long time, caused an ECB to be too dovish, now holding steady on financial stability and price stability. Well, when the slowdown in the production network drags down sectoral activities, what will the slowdown in the monetary mechanism have on investment trends? The Russian crisis is an important externality, and changing positions at this point will bring risks with adverse effects. If the crisis turns to diplomacy, if the sanctions are eased and the supply of goods remains at the level of only post-pandemic ruptures, the ECB will be in a position to increase interest rates more easily. In fact, these economic factors lie behind the failure of actors like Germany to allow energy sanctions. Input supply and flow from Russia should continue.

 

Therefore, a higher-than-expected price stability emphasis emerged in a meeting that could delay interest rate hikes or delay the termination of large-scale asset purchases. The possibility of a rate hike in 4Q22 was also kept alive, because the detail underlying the lowering of the statement that interest rates might be lower comes from the fact that negative rates are not sustainable. In other words, the ECB has adjusted its rhetorical approach that interest rates may increase rather than remain constant. The market awaits Lagarde's statements.

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