Even before the coronavirus threat to Europe disappears, its economy is facing the shock of the Russian invasion of Ukraine. The cost of the war and sanctions on Russia announced by the international community will certainly be significant, putting obstacles in the way of the Eurozone recovery that was expected to continue this year at a strong rate of 4%.
European Commission Vice President Valdis Dobrovskis made a first general assessment after the informal Ecofin last Tuesday, saying the impact on inflation and the economy is significant and is not expected to subside any time soon.
For his part, EU Economic Affairs Commissioner Paolo Gentiloni stressed that the invasion of Ukraine will further intensify pressures on energy prices, which are now expected to remain high for the whole of 2022, but also in the supply chain. “Overall, this combination is likely to have a significant impact on the expected economic growth in the EU, but without derailing it,” he added.
The two leading figures of the Commission left open the possibility, depending on the developments, of the extension of the suspension of the fiscal rules and in 2023, with the relevant decision to be expected in May, when the spring forecasts of the Commission will be presented.
For 2022, the fact that fiscal rules do not apply gives, in principle, relative flexibility in dealing with the immediate effects of war
By 2023, the lifting of the general escape clause from the Stability and Growth Pact had been launched and the Commission’s first recommendations were that a gradual adjustment should be made to reduce public debt, but without adversely affecting growth.
However, if the effects of the war prove to be too great, the Commission will have the option of extending the escape clause for next year.
Pending decisions by the ECB
The war in Ukraine will also affect the decisions of the European Central Bank (ECB) on monetary policy next Thursday, March 10, when its Board meets.
Prior to the Russian invasion, the dominant view of the ECB, as evidenced by the minutes of the Board meeting. On February 3, the time had come for the full bond-buying (APP) program to end in September or even earlier, due to rising inflation, to pave the way for its first rate hike. after more than ten years.
The ECB slowed its bond markets sharply last month, culminating in the week ending February 25, when total net purchases – through this month’s PEPP and the APP – were less than € 1 billion.
This decline has contributed to the significant increase in Eurozone government bond yields since the beginning of the year, which, however, was partially reversed in the last week.
The shift to a restrictive policy was indirectly indicated by Christine Lagarde, in her interview after the meeting on February 3, when she refused to repeat, as before, that an increase in interest rates in 2022 is unlikely.
After the war, however, the ECB will have to take into account the new data created by it.
Any decisions taken by the ECB will be based on a reassessment of the prospects of the European economy requested by Lagarde from the bank’s executives, who will of course take into account the further increase in the cost of energy and some other raw materials and make an impact assessment. that they will have in inflation and growth.
A crucial factor for the decisions will be the new forecasts for price increases in 2023, as the ECB is aiming for 2% inflation in the medium term, which covers a period of roughly two years. In December, the ECB forecast that inflation would be 1.9% in both 2023 and 2024.
If the new forecast is that inflation will move significantly above 2% next year, a key criterion set by the ECB to pursue a restrictive monetary policy will have been met. The question is whether this decision will also apply in the event that the ECB predicts a major impact on growth.
According to information that has seen the light of day, a significant number of members of the Board. of the ECB is still in favor of the termination of QE and there is a possibility that such a decision will take place next Thursday, if the forecasts are in this direction. Money markets, however, which were expecting two interest rate hikes from the ECB in the last quarter of 2022 before the Russian invasion, are now expecting their first rate hike in January 2023.
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