Central Banks

ECB set to stay the course despite rising inflation and political tensions

Krisztian Bocsi | Bloomberg | Getty Images

When the European Central Bank meets this week, the economy looks in good shape, with headline inflation for the euro zone standing at 2 percent, the ECB´s target.

But ECB President Mario Draghi and his team look set to continue its stimulus program up as they watch and wait to see if inflation is here to stay or merely driven by energy prices and whether the political risks from elections in the Netherlands and France are realised.

"With headline inflation in the euro zone back at the magic 2 percent, the ECB hawks and critics will gradually sense that their moment has come to push for tapering," writes Carsten Brzeski, Chief Economist Germany and Austria, with ING in Frankfurt.

"In our view, however, they will not want to add any new uncertainty in the eve of two important elections in the Eurozone."

The ECB is expected to increase its inflation outlook for this year with the publication of its quarterly forecast of inflation and growth for the next 3 years, until 2019. It will probably keep the inflation estimate for 2019 at 1.7 percent. No further changes in the bank's massive quantitative easing bond-buying program, are expected either.

"Importantly, to avoid fueling expectations of any further reduction in QE, the ECB is unlikely to change the 2019 forecast of 1.7 percent at the meeting, which is slightly below target," writes Anatoli Annenkov, ECB-watcher at Societe Generale Group in a note. "The sustainability of the growth outlook and the pass-through of indirect, and possible second-round, effects into core inflation will be the focus for the ECB this year."

While euro zone consumer prices rose 2 percent in February, the highest annual rate of inflation since January 2013, core inflation is still low at 0.9 percent. That is because the so called headline number includes volatile energy prices such as oil, which have nearly doubled since January 2016 and is seen as the major force behind the inflation upturn.

Economic growth in the euro zone at the same time is strong. A survey among purchasing managers, the PMI Composite, posted a reading of 56 in February, showed an almost six-year high as volumes of new orders and export business supported the region's manufacturers while the service sector also gained traction.

"The acceleration in growth, employment and prices signaled by the survey suggest that analysts will begin to pull forward their expectations of when the ECB could begin tapering its stimulus," Chris Williamson, chief business economist at IHS Markit, commented in the release.

Tapering or a shift away from the ultra-loose monetary policy will most likely not be on the agenda until later this year -- or even early next. Economist polled by Reuters are divided as to whether what comes first: Either tweaks to the ECB's forward guidance or a reduction in the monthly asset purchases.

Those who believe that it will be the latter, only expect that to happen only next year.

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