Significant rise in inflation amid a firming recovery predicted by European Central Bank

Jasper Jolly
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Mario Draghi Visits The Bundestag
Mario Draghi leads the ECB's Governing Council (Source: Getty)

Europe's economy is recovering "at a moderate but firming pace" but headline inflation will rise "significantly" in the coming months, according to the monetary policymakers at the European Central Bank (ECB).

The ECB also said Brexit uncertainty and the election of Donald Trump presented risks to the EU economy, while "political uncertainty remained high".

In minutes from the interest rate-setting Governing Council's last monetary policy meeting, the ECB said "strong upward base effects in the annual rate of change of energy prices" would help to push up prices.

Read more: Euro plummets as ECB extends QE programme but begins tapering

US President-elect Trump's fiscal policies were also seen as a possible source of "upward impact" on prices in the Eurozone.

However, the ECB's chief economist, Peter Praet, said underlying inflation (excluding volatile energy prices) lacked "a convincing upward trend" – meaning the ECB had "revised down" the core inflation outlook.

The minutes recorded discussions from the ECB's last monetary policy meeting, which took place on 8 December last year. At the meeting the bank extended its quantitative easing programme but reduced its scale from €80bn per month to €60bn per month.

ECB president Mario Draghi was keen after the meeting to emphasise the bank's continued commitment to accommodative monetary policy. The minutes record Praet raising the possibility of raising quantitative easing purchases back to €80bn per month "if the outlook became less favourable, or if financial conditions became inconsistent with further progress towards a sustained adjustment of the inflation path."

Read more: At long last: Eurozone producer prices rise for first time since June 2013

However, the minutes also reveal a fear that more changes to quantitative easing (officially known as the asset purchase programme) would be needed to combat bond scarcity.

Quantitative easing aims to free up money from bank balance sheets for lending by purchasing a limited selection of government bonds. However, the scale of the ECB's purchases meant it had struggled to find eligible bonds.

The next monetary policy meeting in Frankfurt will take place on 19 January, with little expectation of a change in interest rates or a modification to the quantitative easing regime.

How to understand the European Central Bank's interest ratesĀ 

The European Central Bank (ECB) has three rates:

  • The main refinancing operations: what banks pay to borrow from the ECB

  • The rate on the marginal lending facility: the rate at which banks lend to each other overnight

  • The deposit facility: the rate banks receive to leave money with the ECB overnight

The ECB has kept interest rates unchanged since March 2016, when all three were cut. They have since stayed at zero per cent, 0.25 cent and minus 0.40 per cent respectively.

If a rate is negative the bank will pay the ECB (rather than receiving money in interest). Negative rates are intended to encourage banks to lend money to businesses rather than holding it themselves or, as is the case with the deposit facility rate, depositing it with the ECB overnight.

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