Key interest rate at zero percent: the ECB is reducing its bond purchases more quickly

The European Central Bank (ECB) is leaving the key interest rate unchanged and will continue to buy bonds for the time being.

This was announced by the Governing Council of the ECB, the central bank's highest monetary policy body, on Thursday.

The bond purchases of the PEPP crisis program are scheduled to expire at the end of March.

The so-called deposit rate remains at minus 0.5 percent, so banks must continue to pay negative interest on their deposits with the central bank.

“If incoming data supports the expectation that the medium-term inflation outlook will not weaken even after our net asset purchases end, the Governing Council will end net purchases under the APP in the third quarter,” the central bank wrote.

With regard to possible interest rate hikes, the Council was still reticent to make any statements.

"Any adjustments to the key ECB interest rates will take place some time after the end of the Governing Council's net purchases under the APP and will be phased in," it said.

The Council emphasized the flexibility with which it is important to proceed in view of the new uncertainty caused by the Ukraine war.

ECB President Christine Lagarde will explain the details at the subsequent press conference.

The ECB is evidently proceeding cautiously in view of the new imponderables for the euro area economy.

However, it does not seem to be fundamentally putting the planned normalization of monetary policy on hold.

Interest rate expectations had fallen with the war

At the previous meeting of the ECB Council in early February, Lagarde caused a stir because, when asked, she no longer wanted to rule out that key interest rates could rise this year.

This had caused interest rate expectations on the financial markets to rise significantly.

Commerzbank chief economist Jörg Krämer had even expected that the central bank would now abolish negative interest rates in two steps this year.

Since the attack on Ukraine, however, expectations for interest rate hikes have declined.

Christian Keller, the chief economist at Barclays Bank, now expects no more rate hikes at all this year.

However, the assessments of the ECB observers differ on this question.

The central bank is facing a major challenge: on the one hand, inflation has risen sharply.

This has also forced the central bank to revise its inflation forecasts.

On the other hand, the Ukraine war has caused new uncertainty, also with regard to economic development.

Now there is the terrible war.

And with it the concern that the economy in the euro zone could be exposed to more serious upheavals.

This could mean “stagflation”: very weak economic development combined with high inflation due to the energy price shock.

"Individual representatives of the Governing Council of the ECB no longer wanted to rule out a stagflation scenario for the euro zone," says Christian Reicherter, analyst at DZ Bank: "We think it is quite likely that these fears with a view to the current and coming quarters become reality.”

"That is the greatest risk: that we will have the same experiences as in the 1970s," long-time ECB chief economist Otmar Issing told the Bloomberg news agency.

Stagflation is "the worst combination for a central bank".

He recommended that ECB Governing Council members focus on containing inflation and start reducing asset purchases.

Economist Fratzscher expects inflation of up to 10 percent

In February, the inflation rate in the euro area was already 5.8 percent.

Because of the delays in data collection, this does not even include the sharp rise in energy prices after Russia's attack on Ukraine.

Accordingly, inflation is likely to rise further.

The head of the Munich Ifo Institute, Clemens Fuest, said on Bavarian radio on Thursday that if there were to be a supply stop for Russian gas, "prices would rise again very sharply".

Then it could be "significantly more" than five percent.

The President of the German Institute for Economic Research (DIW), Marcel Fratzscher, went one step further with regard to inflation and warned of inflation of up to ten percent as a result of the war.

"There will probably be inflation rates of well over five percent in the current year," he told the "Neue Osnabrücker Zeitung".

"In the event of an escalation of the war and more and more new sanctions, it can even go towards ten percent."

In any case, the new situation means more uncertainty - and members of the ECB Council such as the French central bank chief François Villeroy de Galhau therefore advocated more "optionality", i.e. the ECB should keep more leeway to react flexibly to possible consequences of the war and to be able to react to the energy price shock.

Apparently, this also found support from other council members.

Flexibility is the "need of the hour," said chief economist Fritzi Köhler-Geib from the KfW development bank.

The head of the Greek central bank, Yannis Stournaras, on the other hand, had publicly advocated staying on the old course for the time being - and buying more bonds at least until the end of the year.