ECB signals first rate hike in 11 years

Christine Lagarde this Thursday (9) sought to counter concerns that the ECB (European Central Bank) was not doing enough to fight inflation, which has been hitting record highs, and announced plans to raise interest rates. above zero for the first time in a decade in September.

The ECB surprised markets after signaling on Thursday, after its policy council meeting in Amsterdam, that it would likely raise interest rates by half a percentage point in September, in addition to the 0.25% hike already forecast for July.

Frederik Ducrozet, director of macroeconomic research at Pictet Wealth Management, said that “they have reversed the burden of proof: either inflation improves or they will decree a 50 basis point increase” (0.5%).

Critics have accused the ECB of lagging behind in its countermeasures after inflation hit 8.1% a year – more than four times above the central bank’s 2% a year target – in the 12 months to May. . The latest plans will align eurozone monetary policy more closely with that of the US Federal Reserve (Fed) and the Bank of England, which have already raised rates several times this year. That would leave the central banks of Japan and Switzerland as the last two major monetary authorities to still maintain negative interest rates.

Lagarde and Philip Lane, the ECB’s chief economist, had previously stated that 0.25% increases were “the norm” for monetary policy committee meetings in July and September.

However, the ECB president stressed on Thursday afternoon that the risks in inflationary terms were “mostly bullish”. Central bank officials are increasingly concerned that rising wages and continuing difficulties in global supply chains will drive inflation to take root.

The decision to announce in advance the July interest rate hike and the likely 0.50% increase in September was taken unanimously, and advocates of a softer line were content to avoid a tougher stance for the first time. interest rate hikes, in exchange for leaving the door open to stronger measures in September.

“Many of the tools we have are aimed at producing more inflation, but now we are in the opposite situation and we need to make it fall,” Lagarde said on Thursday, adding that the ECB would “keep the course and the determination”.

The last time the central bank had decreed an interest rate hike was in 2011, and its redeposit rate is currently negative 0.5%, after falling to zero in July 2012 and plunging into negative territory in 2014. , when the region faced a debt crisis.

Government borrowing costs rose in response to the announcement of tougher monetary policy. The ten-year German Treasury bond rose 0.09% percentage point to 1.45%. Riskier bonds experienced stronger rate hikes, with the Italian 10-year bond up 0.25% to 3.62%.

As planned, the bank announced that it would end its acquisition program of 20 billion euros of assets per month in early July.

The ECB announced in a statement that its monetary policy board “intends to raise key central bank interest rates by 25 basis points at its monetary policy meeting in July.” The text added that if inflationary prospects remain as they are or deteriorate, “a larger increase will be appropriate at the September meeting.”

Beyond September, the ECB announced that “we anticipate that a gradual but sustained path of further interest rate hikes will be appropriate”.

The wave of sales in government bond markets has, however, underlined the problems that the ECB’s abandonment of stimulus could cause for heavily indebted countries such as Italy.

Mario Draghi, former president of the ECB and now Italian prime minister, declared on Thursday, before the monetary council meeting, that the rise in inflation in the European Union “was not completely a sign of overheating, but rather the result of a series of supply shocks”. He declared that “there continues to be excess capacity in the economy.”

Investors, meanwhile, are anxious for the ECB to explain what it plans to do to avoid the risk of repeating the erosion suffered by financial markets, which led to the need for bailouts in several countries, including Greece, Portugal and Ireland. , during the 2012 European debt crisis, which nearly destroyed the euro.

Lagarde said the ECB needed to ensure that it maintained increasing positions in government bonds and that higher interest rates did not lead to a “fragmentation” of borrowing costs by governments and companies in individual member countries. “We know how to develop and we know how to put new instruments into operation if and when needed,” she added. “It’s something we’ve demonstrated in the past, and we’ll do it again.”

The ECB president declared that the bank had complete flexibility to decide when and how to put into operation its “combating fragmentation” tools, including the ability to reinvest the proceeds from maturing bonds, in a bonds worth 1.7 trillion euros launched during the pandemic, adding that “we will prevent any fragmentation”.

But she rejected calls for more detail on the circumstances that could lead to the launch of a new bond-buying tool, saying “there is no specific level of rate hikes, or borrowing costs, or spreads on bonds, that can trigger this or that unconditionally”.

The gap between the cost of raising Germany’s 10-year bonds and Italy’s 10-year bonds widened to 2.17 percentage points — the biggest gap since the start of the pandemic.

“It’s almost possible to imagine a hard-line takeover of the ECB,” said Katharina Utermöhl, senior economist at European insurer Allianz. “If there was any compromise, it was towards holding the hard line, not the softer faction.”

Italian bonds are being hit by an “unpalatable combination” between the prospect of stronger interest rate hikes and a lack of detail about new tools that would help stem the rise in sovereign bond rates, said Richard McGuire, a strategist at Rabobank. “Since we don’t know at what point the pain starts, what we have is certainly an invitation for the pressure to build.”

Lagarde said on Thursday that inflation “would remain undesirably high for some time” after an “unprecedented” three-quarters of the items that make up the basket of goods used to calculate inflation saw prices rise by more than 2 % last month.

The pace at which price pressures have intensified in recent months has left hardliners worried that the ECB is falling behind the curve in monetary policy tightening, and has generated calls for more aggressive measures, in line with the Fed’s strategy of raise interest rates by 50 basis points with each increase.

With Russia’s invasion of Ukraine leading to soaring food and fuel prices for European consumers, there is also growing fear among economists that if the supply of natural gas is cut, the eurozone could slide into recession. .

The ECB lowered its growth forecasts and sharply raised its inflation forecasts. Eurozone inflation will rise from 2.6% last year to 6.8% this year, before falling to 3.5% next year and 2.1% the next — and will be above the target for 2% for the entire forecast period.

In March, the central bank had forecast inflation of 5.1% for this year, 2.1% for next year, and 1.9% for the following year;

Growth is expected to be 2.8% in 2022 and 2.1% in each of the following two years, well below the ECB’s March projections, according to the institution. Carsten Brzeski, director of macroeconomic research at ING bank, said projections remained “too optimistic, which will prevent the ECB from doing what it intends” to fight inflation.

There was speculation about how quickly the ECB would be able to start reducing its balance sheet by failing to reinvest the proceeds from maturing bonds into the 4.9 trillion euro portfolio it has amassed. But Lagarde said the issue was not discussed this week and would be left for a later meeting.

The bank announced that reinvestments of this type would continue “for an extended period, after the ECB’s central interest rates begin to be raised and, in any case, for as long as necessary to maintain conditions of ample liquidity and a sound policy stance.” monetary”

(Translated by Paulo Migliacci)