European Central Bank keeps rates steady, despite record 5.1% inflation

The European Central Bank on Thursday kept to its cautious approach in the face of record inflation in the eurozone, but Christine Lagarde, the bank’s president, acknowledged that “the situation has indeed changed” and refused to rule out a rate increase in 2022.

A change in policy was not expected when the central bank’s Governing Council met this week for the first time this year, but pressure has been mounting from all sides as prices in Europe continue to rise. Hours before the meeting in Frankfurt, Germany, the Bank of England raised its interest rate for the second consecutive meeting, to 0.5 percent.

Traders have been at odds with the central bank’s message that the eurozone economy is not ready for higher interest rates. On Wednesday, before the policy announcement, markets had priced in two 10-basispoint increases in the deposit rate this year. The rate is currently negative 0.5%.

Inflation data for the eurozone released Wednesday surprised economists, showing that the rate of price rises in January in the 19 countries using the common euro currency had reached 5.1% compared with a year ago. That was only a slight increase from the 5% rate in December, but set yet another record for the eurozone. Analysts had projected that the January rate would fall to 4.4% — still well above the bank’s set target of 2%.

Lagarde blamed persistently high energy prices and an increase in the cost of food.

“Compared with our expectations in December, risks for the inflation outlook are tilted to the upside,” she said. “Particularly in the near term.”

She noted, though, that the pandemic appeared to be easing, and supply chain issues were expected to follow suit, pointing to a pick up in economic growth later in the year.

But should the economy heat up too quickly, or if there is a worsening of what she called the “geopolitical clouds” hanging over Europe — without specifically referring to the tensions between Russia and the West over Ukraine — inflation could remain high.

The bank’s Governing Council said Thursday that it expected the key interest rates would “remain at their present or lower levels” until policymakers saw inflation “reaching 2% well ahead of the end of its projection horizon and durably for the rest of the projection horizon,” adding that it would tolerate higher inflation in the interim.

The bank also said it remained on track to end its pandemic bond-buying program in March, but maintain support for the economy by continuing another, older bond-buying program.

In December, Lagarde said that it was “very unlikely” policymakers would raise interest rates in 2022, arguing that inflation would ease over the course of the year and settle below the bank’s 2% target, warranting the extension of monetary stimulus.

On Thursday, she refused to repeat that line, saying the council would revisit the situation when it next convenes on March 10.

“The situation has indeed changed,” she said, speaking about inflation in light of the latest data. “So, situation having changed, we need to continue to monitor very carefully, we need to assess the situation on the basis of the data and then we will have to make a judgment.”

Other members of the bank’s Governing Council have pointed to reasons that inflation might remain high longer than expected.

Earlier this year, Isabel Schnabel, a member of the Executive Board, said the transition to a low carbon economy could require higher fossil fuel prices and rising energy bills and could pose “measurable upside risks” to the bank’s inflation projections.

Luis de Guindos, the bank’s vice president, said in a speech last month that inflation would not be “as transitory as forecast only some months ago.”