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ECB promises low rates longer as virus casts shadow over growth

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FRANKFURT (Reuters) – The European Central Bank on Thursday pledged to keep interest rates at record highs for even longer to stimulate sluggish inflation and warned that the Delta variant of the fast-spreading coronavirus poses a risk to the recovery of the euro zone.

The central bank of the 19 countries that share the euro has said it will not increase borrowing costs until it sees inflation hit its 2% target well before the end of its horizon projection and lasting – a controversial decision that generated significant dissent.

We did so to underline our commitment to maintain an always accommodating monetary policy to meet our inflation target, ECB President Christine Lagarde said at a press conference.

She said the ECB wanted to see inflation reach 2% by the middle of its forecast horizon, which currently runs to 2023 and is extended by one year each December, and that any deviation beyond- above the lens should be accidental.

Previous ECB directives indicated that it would hold interest rates at current levels until it was satisfied that inflation expectations were converging towards its target, and that it would stop buying bonds for his quantitative easing program shortly before that.

But a large group within the 25 members of the Governing Council presented various objections to the wording and while Lagarde managed to convince most of the dissidents, Bundesbank chief Jens Weidmann and Belgian central bank governor Pierre Wunsch held firm, said four sources familiar with the discussion.

It was an unusually robust debate, and far more than two people expressed concern, but most were ultimately won over by Lagarde, one of the sources said.

The language change was prompted by the ECB’s new strategy, unveiled earlier this month, under which inflation can be allowed to temporarily exceed its target when particularly strong or persistent monetary support is needed.

Inflation has been above target for most of the past decade, even with rates cut to record levels and stimulus injected.

FILE PHOTO: The logo of the European Central Bank (ECB) in Frankfurt, Germany, January 23, 2020. REUTERS / Ralph Orlowski

The new forward orientation is consistent with the ECB’s rate hike even later than in the previous framework (but) it does not fundamentally change the criteria that will trigger policy normalization, said Frederik Ducrozet, strategist at Pictet.

Still others felt that the ECB was not going far enough.

Unsurprisingly, the big new take on the ECB’s mandate disturbingly resembles the old one with a nice bow on it, said James Athey, chief investment officer at Aberdeen Standard Investments.

The euro strengthened against the dollar after the Lagarde press conference as eurozone government bond yields fell.

William De Vijlder, chief economist at BNP-Paribas, said the currency movement showed the ECB is now seen as less accommodating than the US Federal Reserve, which targets average realized inflation rather than focusing on expectations .

COMPROMISE

Governors of more indebted countries such as Portugal and Italy had come out in force ahead of the meeting to say the new strategy means the ECB should keep the money taps wide open for even longer.

But the inflation hawks, who favor tighter policy and tend to come from less indebted countries like Germany, have been more cautious as they expect price pressures to return sooner.

The ECB expects inflation across the euro area to hit 1.9% this year before falling back to 1.5% in 2022 and 1.4% the following year.

Financial markets do not expect interest rates to rise for at least three years. The ECB last hiked rates in July 2011.

COVID AND INFLATION

The ECB’s inflation target has strayed further from its reach since the onset of the coronavirus pandemic, which Lagarde says remains a threat.

The recovery of the eurozone economy is on track, she said. But the pandemic continues to overshadow, especially as the Delta variant is a growing source of uncertainty.

The ECB has pledged to continue its € 1.85 trillion ($ 2.18 trillion) Pandemic Emergency Purchase Program (PEPP) until the end of the crisis phase of pandemic and at least until March 2022.

He will soon have to decide when to stop it and whether to replace it, at least in part, with other diets.

Conservative policymakers argue that the COVID-19 emergency is fading, so the ECB must abandon its extraordinary powers and revert to more traditional measures, bound by stricter rules and with a closer focus on the return of inflation on target.

But doves who support an easier political stance have warned of the risk posed by the Delta variant, which has already resulted in the partial reinstatement of containment measures in some eurozone countries.

($ 1 = 0.8481 euro)

Additional reporting by Sandor Krisztian; Editing by Catherine Evans

Sources

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2/ https://www.reuters.com/article/ecb-policy/update-5-ecb-pledges-low-rates-for-longer-as-virus-casts-shadow-over-growth-idUSL1N2OY07V

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