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ECB meeting to shed light on response to record inflation

Good morning and welcome to Europe Express.

All eyes turn to Frankfurt today, where the European Central Bank is holding its governing council followed by a news conference where the bloc’s record-high inflation will be top of the agenda. We will explore the issues and why analysts and reporters will seek to parse out any signs of upcoming shifts in monetary policy.

On the Russia-Ukraine front, El País got its hands on the written replies the US and Nato sent to Moscow — which the Biden administration confirmed yesterday and in which there are renewed offers for transparency on missile deployment and disarmament (which Russia rejected in the past). Washington also announced sending 2,000 troops to Poland and Germany and redeploying roughly 1,000 troops to Romania.

And in our profile this week, we’ll look at the EU energy commissioner, Kadri Simson, who is headed to Azerbaijan tomorrow in an attempt to secure more back-up gas supplies for the bloc in case the Russia conflict flares up.

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Looking for hawkish signs

Two months ago, Christine Lagarde dismissed rising inflation as a passing “hump” that was near its peak and said the European Central Bank was “very unlikely” to raise interest rates in 2022.

Since then inflation has surpassed all expectations to set a new eurozone record of 5.1 per cent in January — well above the ECB’s 2 per cent target — and investors are now betting it will raise rates several times this year, writes Martin Arnold in Frankfurt.

The increasing cost of living, driven by soaring energy and food prices, is top of the agenda as the ECB governing council meets today and investors will listen carefully for any hint from the ECB president of a “hawkish” shift in policy.

Here are the three big questions:

Will the ECB raise rates this year?

Last year, as part of a new strategy, the ECB set three conditions to raise its deposit rate, which has been negative since 2014. First, it has to stop net bond purchases. It has said these will continue at least until October — but that does not preclude a December rate rise, something Deutsche Bank economists are now predicting.

Second, it requires “realised progress in underlying inflation is sufficiently advanced to be consistent with” inflation hitting its target. This is hard to measure. But core inflation, excluding energy and food, is already more than 2 per cent — so it must be close.

Finally, the ECB needs to forecast inflation at its target over much of the next two years. In December, it forecast inflation would drop to 1.8 per cent next year and stay there in 2024, which means Lagarde can say its conditions have not been met. The big question, however, is whether she still dismisses a 2022 rate rise as “highly unlikely”.

Will the ECB raise its inflation forecast?

Reinhard Cluse, chief economist for Europe at UBS, said eurozone inflation will stay around 5 per cent until July. The ECB recently forecast it would fall below 4 per cent by the summer. It will issue new forecasts in March, when Frederik Ducrozet at Pictet Wealth Management believes “upward revisions to staff projections are very likely”.

Philip Lane, the ECB’s chief economist, last week said it would be “driven by the data” and outlined three inflation scenarios: in one it falls below 2 per cent by next year, in a second it stabilises at its target and in a third it stays “significantly above” its target. He told the Lithuanian newspaper Verslo žinios the latter scenario was “less likely than the other two”. 

Do the Russia/Ukraine tensions change the picture?

If the drumbeat of war continues or Russia invades, it is likely to raise energy prices. BNP Paribas economists forecast a Ukraine invasion would lift eurozone inflation above 6 per cent.

Lane pointed to the impact of such “geopolitical events” on the European economy through trade as well as prices and uncertainty. So Lagarde could say a conflict in Ukraine is a downside risk for the economy, requiring it to maintain its supportive monetary policy.

Chart du jour: Turkish backing

Column chart of Defence and aerospace exports showing Turkey's defence sales to Ukraine have grown in recent years

Turkey’s President Recep Tayyip Erdogan visits Kyiv today in a show of support for Ukraine underpinned by weapons sales that have become an irritant in Turkey-Russia relations. Ankara also opposed Moscow’s 2014 annexation of Crimea, driven by a centuries’ long suspicion of Russian expansionism and concern for the Crimean Tatar minority. (More here)

Security of supply

The EU’s Estonian energy commissioner has been propelled into the role of gas crisis fighter, flying across the world to desperately secure additional supplies from major producers that are not Russia’s, writes Mehreen Khan in Brussels.

Kadri Simson, who has served as EU energy commissioner since 2019, will be in Baku tomorrow in Brussels’s latest attempt to coax the world’s major liquefied natural gas producers (LNG) into ramping up supplies in light of a potential squeeze on Russian imports.

The EU’s decision to go cap in hand to Azerbaijan — a former Soviet state and Turkey ally — shows the extent to which desperate times are calling for desperate measures. The Azeris have a 25-year deal to provide 10 bcm a year of LNG to the EU — the bulk of which goes to Italy. On her visit to Baku, Simson will reiterate the importance of Azerbaijan’s imports and the possibility of boosting volumes, said an EU official.

Simson also met representatives from Qatar, the world’s largest producer of LNG, this week and on Monday will head to Washington for the revived EU-US energy council to bang the drum for more American LNG to Europe.

Simson’s world tour comes as the EU is getting serious about security of supply amid constant worries about a Russian incursion into Ukraine. Russia accounts for about 40 per cent of all EU natural gas imports. LNG imports from the rest of the world make up roughly 20-25 per cent. Europe’s threats over applying crippling sanctions on Russia sound hollow unless the bloc has a real contingency plan to cope without Moscow’s gas flows.

Brussels insists no major infrastructure bottlenecks exist to prevent additional volumes of LNG being pumped into the continent’s pipelines over the next months. About a third of the EU’s capacity remains free. The US is working on plans to help divert supply from Qatar intended for the Asian market to help out Europe.

For now, Simson has struck a sanguine note on the EU’s diversification efforts. She told MEPs yesterday that increased LNG imports in January “showed that Europe can count on a diversified and fully functioning gas infrastructure. There is still spare capacity that can be used to receive even additional gas supplies in our LNG terminals.”

What to watch today

European Central Bank governing council takes place in Frankfurt

Turkey’s President Recep Tayyip Erdogan visits Kyiv to show support

EU Brexit commissioner Maros Sefcovic has a virtual meeting with UK foreign secretary Liz Truss

EU home affairs ministers meet for an informal council in Lille, France

Notable, Quotable

I can now direct the checks to cease in the absence of executive approval

Checks no more: Northern Ireland’s agriculture minister has ordered a halt to post-Brexit customs checks on food imports from Great Britain, in the most concrete defiance to date of trading rules put in place when the UK left the EU a year ago. The development is likely to feature at today’s virtual meeting between Maros Sefcovic, the EU’s Brexit commissioner and UK foreign secretary Liz Truss.

Taxonomy resistance: EU commissioners from Portugal, Spain and Austria voted against the new ‘taxonomy’ on sustainable finance yesterday, reflecting the position of their governments. The rare show of dissent in internal commission meetings failed to bloc the adoption of the rule book, however.

Nuclear fusion: European industrial giants Siemens and Thales have joined the race to create cleaner energy through nuclear fusion, a nascent industry which does not produce long-lasting radioactive waste and carries no risk of reactor meltdowns. Last year, the industry attracted more than €2.3bn in venture capital funding, predominantly for companies based in the US.

Make way for Bezos: The Netherlands city of Rotterdam is set to partly dismantle a century-old bridge so that a pleasure yacht being built for Amazon founder Jeff Bezos can sail through, according to reports in local media.

Take action: A new paper by Digital Europe will argue the “window of opportunity” to act is closing to deliver on the key objectives ahead of the next meeting of the Trade and Technology Council in May.

Britain after Brexit — Keep up to date with the latest developments as the UK economy adjusts to life outside the EU. Sign up here

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Today’s Europe Express team: martin.arnold@ft.com, mehreen.khan@ft.com, valentina.pop@ft.com. Follow us on Twitter: @MAmdorsky, @MehreenKhn, @valentinapop.

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