- All rates increase by 50 basis points
- Inflation will remain “undesirably” high
- The ECB supports the “anti-fragmentation” tool called TPI
- The ECB “can go very well” on this, Lagarde says
FRANKFURT, July 21 (Reuters) – The European Central Bank raised interest rates more than expected on Thursday, as worries about rampant inflation outweighed concerns about growth, although the economy the eurozone is suffering the impact of the Russian war in Ukraine.
The ECB raised its benchmark deposit rate by 50 basis points to zero percent, breaking its own orientation for a 25 basis point move as it joined its global counterparts to raise borrowing costs. It was the ECB’s first rate hike in 11 years.
Politicians also agreed to offer additional aid to the most indebted nations in the currency bloc of 19 countries, including Italy, with a new bond-buying scheme aimed at limiting the rise in their borrowing costs and thus limiting the debt. financial fragmentation.
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At the end of an eight-year experiment with negative interest rates, the ECB also raised its main refinancing rate to 0.50% and promised further rises, possibly as early as the September 8 meeting and beyond. .
ECB President Christine Lagarde said a clear deterioration in the inflation outlook and unanimous support for the anti-fragmentation instrument justified the larger measure.
“Price pressure is spreading to more and more sectors,” Lagarde said. “We expect inflation to remain undesirably high for a while.” He listed driving factors, such as higher food and energy costs and wage increases.
“We decided on the balance sheet that it was appropriate to take a bigger step towards the exit of negative interest rates.”
But even if the ECB is moving faster, Lagarde said, the terminal rate – or the level at which rises end – has not changed.
The ECB did not provide guidance for its expected rate hike in September, saying only that the additional increases will be appropriate and that decisions will be made meeting by meeting.
The ECB had been guiding markets for weeks to expect a 25 basis point rise on Thursday, but sources close to the discussion said 50 basis points came into play shortly before the meeting as part of an agreement that includes aid for in indebted countries.
With inflation already approaching double-digit territory, there is a risk of tightening well above the ECB’s 2% target, and any shortage of gas over the coming winter is likely to increase prices. , perpetuating the rapid growth of prices.
Lagarde warned that risks to the inflation outlook were on the rise and have intensified, mostly because the war is likely to drag on, keeping energy prices high for longer.
Economists surveyed by Reuters had forecast a 25 basis point increase, but most favored a 50 basis point increase, raising the ECB’s record-breaking 0.5% deposit rate to zero. Read more
The euro rose 0.8% to $ 1.0261, after trading at $ 1.0198 just before the statement, but turned negative the day Lagarde spoke. Markets are now trading at a rate hike of almost 50 basis points in September and see a combined increase of 124 basis points over the rest of the year.
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The new bond purchase scheme, called the Transmission Protection Instrument (TPI), aims to limit the rise in loan costs to the entire currency block as the policy tightens.
“The scale of TPI purchases depends on the severity of the risks faced by the transmission of policies,” the ECB said in a statement. “The ICC will ensure that the direction of monetary policy is smoothly transmitted to all euro area countries.”
As ECB rates rise, lending costs increase disproportionately for countries such as Italy, Spain or Portugal, as investors demand a higher premium to maintain their debt.
“The ECB is able to make it big for that,” Lagarde said.
The activation of the instrument will be entirely at the discretion of the ECB and the bank will target public sector bonds with maturities of between one and 10 years.
Countries will be eligible if they comply with EU tax rules and do not face “serious macroeconomic imbalances”. Commitments under the EU Recovery and Resilience Mechanism will be needed, as well as an assessment of debt sustainability.
The ECB’s commitment on Thursday comes when a political crisis in Italy is already weighing on the markets following the resignation of Prime Minister Mario Draghi, who was Lagarde’s predecessor at the ECB.
The yield differential between the Italian and German 10-year bonds widened to 246.5 basis points during the Lagarde press conference, not far from the 250 basis point level triggered by an emergency policy meeting. of the ECB last month.
The ECB’s 50 basis point rise still leaves it lagging behind its global counterparts, especially the US Federal Reserve, which raised rates by 75 basis points last month and is likely to move by a similar margin in July.
But the eurozone is more exposed to Ukraine’s war and a threat to cut off Russia’s gas supply could drop the bloc into recession, leaving policymakers with a dilemma of balancing considerations of growth and inflation.
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Written by Mark John; Editing by Toby Chopra, John Stonestreet and Catherine Evans
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