ECB Signals Raising Rates, Eyes Bigger Move in September

FRANKFURT/AMMSTERDAM (Reuters) – The European Central Bank ended a long-term stimulus plan on Thursday and said it will implement next month its first interest rate hike since 2011, followed by a bigger move likely in September.

With inflation hitting a record 8.1% and still rising, the European Central Bank now fears that price growth is widening and could turn into a hard-to-break vortex in wage prices, ushering in a new era of stubbornly high prices.

The central bank of the 19 countries that use the euro said it would end quantitative easing on July 1, and then raise interest rates by 25 basis points on July 21. Inflation prospects are improving in the meantime.

“We will make sure that inflation returns to our 2% target over the medium term,” European Central Bank President Christine Lagarde told a news conference. “It’s not just a step, it’s a journey,” she said of the moves noted Thursday.

Sources told Reuters that some policymakers backed a larger move in July but eventually gave in and the final policy decision was approved unanimously. Read more

The rapid rise in inflation was initially driven by energy and food prices as economies emerged from the COVID-19 lockdowns but Russia’s invasion of Ukraine accelerated these trends and even core inflation is now double the ECB’s target.

ECB policymakers have discussed the scale of rate hikes extensively, with Chief Economist Philip Lane favoring 25 basis points in July and September, but others have argued that 50 basis points should be taken into account.

In support of their case, the European Central Bank raised its inflation forecast again, to 6.8% for this year versus the previous forecast of 5.1%. Inflation is forecast to be 3.5% in 2023 and 2.1% in 2024, the fourth consecutive year of overshooting.

Lagarde said that was too high and a similar forecast three months from now would require faster price increases.

“If I were at 2.1% in 2024 or later, the increase in adjustment would be even higher? The answer is yes,” Lagarde said.

A 50 basis point hike, the next logical increase, would be the ECB’s largest one-time increase since June 2000. At -0.5%, the ECB deposit rate has been in negative territory since 2014.

What is behind the bend?

“Given that our forecasts point to a further increase in core inflation in the eurozone in the next few months, we now expect the ECB to raise rates by 25 basis points in July, and by 50 basis points in September,” said Frederic Ducrozet, a strategist at Pictet. “.

“We expect the ECB to return to ‘standard pace’ in 25 basis point increments, but likely to pick up in October and December, and the 50 basis point option will likely remain on the table until core inflation eases significantly.”

By late Thursday, markets were setting 144 basis points for rate hikes this year, which means an increase at every meeting from July, with several moves in excess of 25 basis points.

They were expecting 240 basis points of moves in the deposit rate by the end of 2023, bringing the interest rate peak close to 2%.

Lagarde, who said earlier this year that a 2022 price hike was more appropriate in times of great uncertainty, than if the path was clear and well defined and we all understand where we’re going. Not very similar.

Some economists have argued that the ECB is already too late to tackle inflation, so raising interest rates to the neutral level, where it neither stimulates nor dampens the economy, will not be enough.

“The ECB is still behind the curve,” said Joerg Kramer, chief economist at Commerzbank.

“It’s not enough just to take her foot off the gas, you have to hit the brakes as well,” Kramer said. “But that is exactly what it was not prepared to do, which is why we expect inflation to exceed 2% in the coming years.”

The first rate hike by the European Central Bank in more than a decade will still lag most of its global peers, including the US Federal Reserve and the Bank of England, who raised aggressively and promised more action.

Unlike the Fed, the ECB has no plans to shrink its balance sheet, as policy makers reaffirm their commitment to continue reinvesting outstanding liquidity from the €5 trillion in public and private debt held by the ECB.

Even as she promised to raise interest rates, Lagarde vowed not to allow the borrowing costs of the countries of the previous debt crisis in the eurozone to be pushed too high by financial markets again. “We are committed and committed!” Lagarde said. [nL1N2XW1BX]

And while the start of policy tightening has now been determined, the end point remains uncertain.

While Lagarde said prices should move towards the neutral point, this level is unmarked and unobservable, leaving investors guessing how far the ECB wants to go. Read more

Additional reporting by Francesco Canepa in Frankfurt and Mark Jones in London. Editing by Catherine Evans

Our criteria: Thomson Reuters Trust Principles.