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Market Extra: ECB to speed taper of bond buys as Russia’s invasion of Ukraine sparks stagflation fears

The European Central Bank on Thursday called Russia’s invasion of Ukraine “a watershed for Europe” and moved to speed the tapering of its asset-buying program in response to rising inflationary pressures.

In a statement following its policy meeting, the Governing Council said it would purchase €40 billion in assets in April, €30 billion in May and €20 billion in June. The ECB had previously planned to make purchases of €40 billion a month through the second quarter, scaling back to €30 billion in the third quarter and €20 billion in the fourth quarter. The ECB said it could end purchases in the third quarter if the outlook for inflation doesn’t show signs of easing.

Any interest rate increases would come “some time” after bond purchases ended, the ECB said, in contrast to its previous language that said hikes would come “shortly after” the completion of purchases.

The ECB on Thursday faced its first policy decision following Russia’s invasion of Ukraine two weeks ago. The shift surprised economists and investors, who had thought the central bank was likely to stand pat as it weighed the inflationary impact from the resulting surge in prices for energy and other commodities versus the potential hit to economic growth.

ECB President Christine Lagarde, however, insisted that the Governing Council wasn’t accelerating the tapering process, but instead sticking to its framework for adjusting policy in a data-dependent fashion, a line that economists said was difficult to accept.

Overall, however, the reason for the ECB’s change of gear was clear, said Carsten Brzeski, global head of macro at ING, in a note.

“The war in Ukraine has strongly increased the risk of stagflation in the eurozone,” he said.

“Extremely high energy and commodity prices, potential energy supply disruptions, weaker trade, new supply chain disruptions and a high degree of uncertainty for both companies and consumers have changed the eurozone’s economic prospects in only a few days,” Brzeski said.

The euro
EURUSD,
-0.72%
,
which had slumped to a nearly 22-month low last week, rebounded sharply versus the dollar after the ECB announcement, but came under renewed pressure after data showed U.S. inflation continued to accelerate toward a 40-year high. The shared currency was down 0.7% at $1.0995.

European government bond yields rose. The yield on the 10-year Italian government bond
TMBMKIT-10Y,
1.918%

jumped more than 30 basis points to 1.895%.

Thursday’s announcement sets markets up for an “odd” second quarter, said Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics.

For Italian bonds, which have seen yields rise on fears over the end of asset buying, yields will fall if evidence emerges that the war is “morphing into a nasty growth shock, while evidence that the economy is taking the conflict in its stride will be met with higher yields, as it solidifies the ECB’s decision to end QE by Q3,” he said.

Vistesen said inflation data is likely to only get more difficult for the ECB, with growth unlikely to slow enough to let the central bank “off the hook” by June, making it likely that asset buying comes to an end in June.

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