ECB's pledges low rates for long and warns about Delta variant

© Reuters. FILE PHOTO: The European Central Bank (ECB) logo in Frankfurt, Germany, January 23, 2020. REUTERS/Ralph Orlowski

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) - The European Central Bank pledged on Thursday to keep interest rates at record lows for even longer to boost sluggish inflation and warned that the Delta variant of the coronavirus posed a risk to the euro zone's recovery.

The central bank of the 19 countries that share the euro said it would not hike borrowing costs until it sees inflation reach its 2% target "well ahead of the end of its projection horizon and durably".

"We did so to underline our commitment to maintain a persistently accommodative monetary policy stance to meet our inflation target," ECB President Christine Lagarde told a news conference.

The shift in language was prompted by the ECB's new strategy, unveiled earlier this month, when it promised to be "especially forceful or persistent" and even let inflation edge above 2% because interest rates are near rock-bottom.

Inflation has lagged the ECB's target for most of the past decade and the goal has slipped further from its grasp since the onset of the coronavirus pandemic.

COVID-19 remains a threat to the euro zone economy even as businesses reopen and people emerge from lockdown, Lagarde said.

"The reopening of large parts of the economy is supporting a vigorous bounce-back in the services sector," she said. "But the Delta variant of the coronavirus could dampen this recovery in services, especially in tourism and hospitality."

COMPROMISE

The change in language was not backed by all ECB policymakers.

"We did not have unanimity but we had an overwhelming majority (for) the calibration of the forward guidance on ECB interest rates," Lagarde said, adding that she had anticipated opposition.

Governors from indebted countries such as Portugal's Mario Centeno and Italy's Ignazio Visco came out in force before the meeting to argue that the new strategy means the ECB should keep the money taps wide open for even longer.

But inflation hawks, who favour tighter policy and tend to come from countries with lower debt-to-GDP ratios like Germany, have been more cautious, as they expect price pressures to return sooner.

Inflation in Germany is already set to surpass 2% this year due to temporary factors.

The ECB expects inflation in the euro zone as a whole to hit 1.9% this year before falling back to 1.5% in 2022 and 1.4% the year after.

Financial markets are not pricing in a rate hike for at least three years.

BIG DECISIONS AHEAD

The forward guidance will inform the ECB's approach to fundamental decisions that must be made at coming meetings, including how to wind down its 1.85 trillion euro ($2.18 trillion) Pandemic Emergency Purchase Programme (PEPP) and whether to replace it, at least in part, with other schemes.

Conservative policymakers argue that the COVID-19 emergency is fading so the ECB needs to give up its extraordinary powers and revert to more traditional measures, bound by stricter rules and with a narrower focus on getting inflation back to target.

But doves who back an easier policy stance have warned about the risk posed by the fast-spreading Delta variant, which has already caused curbs to be partially reinstated in some euro zone countries.

Under the PEPP, the ECB can buy bonds wherever it deems it necessary and without pre-set volume quotas.

The longer-established Asset Purchase Programme, however, requires purchases in proportion to the size of each of the euro zone economies, known as the capital key, at pre-set volumes, and excludes heavily-indebted Greece because its credit rating is too low.

($1 = 0.8481 euros)