inflation targets

ECB expected to revisit bond policy following Fed rate hike

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Hooked on inflation – but only a little. Source: picture alliance

With the North Korea-US summit complete and the second of three expected rate hikes in the US on the books, the attention is now on the European Central Bank. Investors are hoping for a clear signal from Frankfurt that its government bond-buying program is coming to an end.

The Federal Reserve Wednesday bumped its key interest rate by a quarter point to a new range between 1.75 percent and 2 percent. Inflation data published on Tuesday shows consumer prices in May rose by 2.8 percent year-on-year, the strongest increase since February 2012. “Inflation rates once again demonstrate the need for a tightening of monetary policy,” said Thomas Gitzel, chief economist of VP Bank in Liechtenstein, ahead of the Fed’s action.

The Fed also surprised investors by releasing an unusually brief announcement that upgraded its language on the US economy. It also now expects two more rate hikes this year, rather than just one more as previously telegraphed.

To stop or not to stop

The Fed is currently facing a difficult balancing act: On the one hand, it does not want to slow the economy too much, in order to avoid a recession. On the other hand, prices could rise more in the medium term. Compared to the euro zone, the US government’s fiscal policy provides particularly strong support for growth, primarily due to the massive tax relief at the beginning of the year.

The ECB is likely to discuss and possibly decide on the future of its controversial bond purchases at its external meeting in Riga, Latvia. The central bank is currently buying €30 billion a month, mainly government bonds from euro countries, to boost inflation in the currency zone. The purchases are set to run through September and investors want a roadmap for the following months.

Commerzbank chief economist Jörg Krämer expects the ECB to announce on Thursday that it will stop buying bonds at the end of the year. Still, he sees the central bank committing more strongly to keeping interest rates at their current level. “It will do everything in its power not to portray this as the beginning of a classic cycle of interest rate hikes,” said Krämer. Savers will have to be patient. Krämer doesn’t see an ECB interest-rate hike before the summer of 2019.

No one is certain how far the ECB will actually go on Thursday in terms of ending its bond-buying program. However, ECB chief economist Peter Praet added fuel to the fire in a speech last week in which he expressed unusual optimism about growing inflation.

Euro-zone inflation is now at 1.9 percent, closing in on the 2 percent target set by the ECB. But the bump was mainly due to higher energy prices while the core rate adjusted for particularly volatile goods such as oil, tobacco and food was only 1.1 percent.

Praet left open whether a bond decision will be announced at Thursday’s meeting. Weaker economic indicators and political uncertainty in Italy argue against a decision at this time. Some economists think the ECB will take its time with any such decision.

Jan Mallien covers monetary policy for Handelsblatt in Frankfurt. Andrew Bulkeley adapted this story into English for Handelsblatt Global in Berlin. To contact the author: mallien@handelsblatt.com

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