ECB raises rates more than expected to fight runaway inflation

  • All rates increase by 50 basis points
  • Uncomfortably high and rising inflation
  • The ECB also approves the “anti-fragmentation” tool called TPI
  • Press conference at 12:45 GMT

FRANKFURT, July 21 (Reuters) – The European Central Bank raised interest rates more than expected on Thursday, confirming that concerns about runaway inflation now outweigh growth considerations, even as the economy in the euro zone is reeling from the Russian war in Ukraine.

The ECB raised its benchmark deposit rate by 50 basis points to zero percent, beating its own forecast of a 25 basis point move as it joined global peers in raising borrowing costs. It was the first rate hike by the eurozone central bank in 11 years.

Ending an eight-year experiment with negative interest rates, the ECB also raised its main refinancing rate to 0.50% and promised further rate hikes, possibly as early as its next meeting on September 8. .

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“Further normalization of interest rates will be appropriate,” the ECB said. “Today’s frontloading of the exit from negative interest rates allows the Governing Council to move to a meeting-by-meeting approach to interest rate decisions,” the ECB said in a statement.

The ECB had for weeks guided markets to expect a 25 basis point hike, but sources familiar with the discussion said 50 basis points had been put on the line shortly before the meeting because indicators pointed to a further deterioration in the inflation outlook.

With inflation already approaching double-digit territory, it is now likely to stay above the ECB’s 2% target and any gas shortages over the coming winter are likely to push prices even higher. , perpetuating rapid price growth.

Economists polled by Reuters had predicted a 25 basis point increase, but most said the bank would actually have to rise 50 basis points, bringing its record deposit rate of minus 0.5% to zero. Read more

The euro, which fell to its lowest level in two decades against the dollar at the beginning of the month, strengthened by around 0.5% following the ECB’s decision.

The ECB also agreed to provide further assistance to the most indebted countries in the 19-nation currency bloc, by approving a new bond-buying program called the Transmission Protection Instrument, intended to limit the rise in their borrowing costs and limit financial fragmentation.

“The scale of TPI purchases depends on the severity of the risks facing policy transmission,” the ECB said in a statement. “The TPI will ensure that the monetary policy stance is transmitted smoothly across all eurozone countries.”

As ECB rates rise, borrowing costs rise disproportionately for countries like Italy, Spain or Portugal, as investors demand a higher premium to hold their debt.

Thursday’s ECB pledge comes as a political crisis in Italy is already weighing on markets following the resignation of Prime Minister Mario Draghi.

The yield spread between Italian and German 10-year bonds briefly exceeded 240 basis points on Thursday and was not far from the 250 basis point level that triggered an emergency ECB meeting last month.

Markets are now looking to ECB President Christine Lagarde’s 12:45 GMT press conference.

INFLATION VS RECESSION

The ECB’s 50 basis point hike on Thursday still leaves it behind its global counterparts, particularly the US Federal Reserve, which raised rates by 75 basis points last month and is expected to move by a similar margin in July.

But the euro zone is more exposed to war in Ukraine and a threat of a gas supply cut from Russia could tip the bloc into recession, leaving policymakers with a dilemma of balancing growth and inflation.

Confidence has already been shaken by the war and high commodity prices are depleting purchasing power.

Rising borrowing costs during a downturn, however, is controversial and could amplify the pain for businesses and households.

But the ECB’s ultimate mandate is to control inflation, and rapidly rising prices for too long could perpetuate the problem as companies automatically adjust prices.

The European labor market is also increasingly tight, suggesting that wage pressure is also likely to keep price growth high.

Some central banks, most notably the Fed, have made it clear that they are ready to crush growth to control inflation, because the risk of a new “regime of inflation” taking hold is too high.

And if a recession is looming, the ECB must anticipate rate hikes so that its tightening cycle ends sooner.

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Editing by Toby Chopra, John Stonestreet and Catherine Evans

Our standards: The Thomson Reuters Trust Principles.

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