European Central Bank's Approach to Handling Inflation

The European Central Bank (ECB) plays a pivotal role in maintaining economic stability across the eurozone. As the central bank for the 19 countries that share the euro currency, the ECB focuses on price stability, financial supervision, and monetary policy. Its primary objective is to ensure price stability, aiming to keep inflation close to 2% over the medium term. Achieving this balance is crucial: excessively low inflation can hinder economic adjustments, while high inflation erodes purchasing power and disrupts economic planning.

The Governing Council and Decision-Making

The decision-making body within the ECB is the Governing Council. Comprising the central bank governors of the eurozone countries and the ECB’s Executive Board members, the council meets approximately every six weeks to assess economic conditions, inflation trends, and financial stability. Their deliberations shape monetary policy and interest rate decisions.

Tools for Influencing Inflation Rates

The ECB employs several tools to influence inflation rates, with interest rates being a powerful lever. There are three key rates:

Main Refinancing Rate: Determines the interest banks pay when borrowing money from the ECB for one week. Adjusting this rate influences overall borrowing costs, impacting mortgages, business loans, and consumer credit. Deposit Facility Rate: Banks receive this rate for overnight deposits with the Eurosystem, affecting the interest they earn on excess reserves. Marginal Lending Facility Rate: Applies to overnight credit provided by the Eurosystem to banks. It serves as a last resort for banks facing liquidity shortages.

The ECB also conducts open market operations by buying or selling securities to inject or withdraw liquidity from the market, further influencing inflation.

Current Monetary Policy Actions

The ECB has recently made several key decisions regarding its asset purchase programs:

Net asset purchases under the Pandemic Emergency Purchase Program (PEPP) will cease at the end of March 2022. The Governing Council decided in December 2021 to reduce the monthly net purchase pace to €40 billion in the second quarter and €30 billion in the third quarter under the Asset Purchase Program (APP). Starting from October 2022, the Governing Council plans to maintain net asset purchases under the APP at a monthly pace of €20 billion for as long as necessary to reinforce the accommodative impact of its policy rates. The Governing Council expects net purchases to end shortly before it starts raising the key ECB interest rates.

I expect the interest rates for:

Main Refinancing Operations (MRO) and the interest rates on the Marginal Lending Facility to remain unchanged at 0.00% and 0.25%, respectively. The interest rate on the Deposit Facility will remain at -0.50% until the end of 2022. As of now, the negative rate applies to deposits, but looking ahead, the rates are expected to become positive.

These actions reflect the ECB's commitment to balancing economic pressures and ensuring that inflation remains within target. By carefully managing interest rates and asset purchases, the ECB aims to promote economic growth and maintain price stability for eurozone countries.