The European Central Bank “High inflation is the biggest challenge for us”, making it clear that they will do everything possible to control prices. The institution has thus confirmed the rise in rates at the next meeting in July (the first rise in money in 11 years) and another one in September. In addition, the ECB has ended net bond purchases (ends July 1). The central bank had telegraphed its next moves, but the unexpected strength of inflation kept markets on edge for a possible surprise that hinted at a change in the central bank’s forward guidance (the ECB’s next steps). The statement confirmed the surprise.
In this way, the ECB has slightly changed the script that its president, Christine Lagarde, presented a few weeks ago. The tone of the statement has been moderately more ‘hawkish’ (aggressive or restrictive) than what Lagarde telegraphed (two increases of 25 basis points in the next two meetings), but it is true that the situation for prices has worsened. It seems that this Thursday’s decision has enjoyed consensus within the central bank.
Inflation is running rampant in the euro zone, marking maximums not seen in the history of the bloc. This sustained rise in the CPI (it is already at 8.1%) has caused a change of direction in the policy of a central bank that could be forced to improvise if prices do not moderate. In a few months, interest rates will leave negative territory in the euro zone after more than eight years below zero.
The central bank has not only announced that it will raise interest rates in July (25 basis points), it has also opened the door to implement “bigger increases” at the September meeting (up to 50 basis points) in an attempt to control inflation. and to control price expectations, which had begun to loosen slightly.
There have only been two occasions in which the rate increase has been equal to or greater than 50 basis points. The first was on January 22, 1999, at its third meeting, when it suddenly raised rates from 125 basis points to 4.5%, in the first month of the euro’s launch on the financial markets, and the second date from June 9, 2000, when the ECB raised rates by 50 basis points to 5.25%.
On the other hand, it must be remembered that the price of money is at record lows despite all the ‘hawkish’ rhetoric. The ECB has confirmed that the price of money will remain at these minimums until the next meeting: the main interest rate remains at 0%, while the credit facility will remain at 0.25% and the deposit facility ( where the banks park their reserves) at -0.5%. In July, all these key rates could change, with the deposit rate taking center stage.
In addition, the central bank has presented the forecasts for the economy with a somewhat pessimistic tone. inflation for this year at 6.8%. The institution’s economists have revised the forecast growth downward. Specifically, it expects the euro zone’s GDP to reach 2.8%, compared to the 3.7% estimated in the outlook for the month of March. It also cuts the forecast GDP for 2023 by seven tenths to 2.1%.
From September…
Beyond September, based on its current assessment, the Governing Council anticipates that a gradual but sustained path of further interest rate increases will be appropriate. “In line with the Governing Council’s commitment to its medium-term target of 2%, the pace at which the Governing Council adjusts its monetary policy will depend on incoming data and how it assesses inflation developments over the medium term” . Rates are expected to continue advancing until reaching an area close to 1%, the level at which the neutral rate would be (the level consistent with sustained inflation at 2% and full employment).
Why haven’t you raised interest rates yet? The ECB had made the end of the APP, the asset purchase program, a sine qua non condition to start raising interest rates. With this Thursday’s announcement, the central bank will officially stop buying debt (in net terms) at the end of this month. Since July 1, the ECB has a free hand to increase the price of money. The key is what the rate of climbs will be.
That is where the big battle is, since a part of the Governing Council prefers to take small steps towards normalization (rises of 25 basis points and calm), while the ‘hawks’ are committed to taking interest rates to positive levels of a single stroke and send a resounding message: inflation is not going to get out of hand. In part, this is the message that has been given in the statement published by the institution. Another mini-point for the ‘hawks’, who seem to have taken control of the central bank.
Abrdn’s economists believe that the difference of opinion within the ECB, the slowdown in the economy and the flexibility that the ECB retains are likely to translate into greater market volatility for rates and bonds. Looming recession risks could also lead investors to price in different European bond premia, causing spreads to widen and eventually requiring ECB intervention.
However, Christine Lagarde has tried to clarify that the ECB will go ‘game by game’, analyzing all the data and making decisions at each meeting as new data appears. François Rimeu, chief strategist at La Française AM, believes that “thePresident Lagarde has done well to stress that the pace of policy tightening will depend on the data (i.e. domestic demand, core inflation and financial conditions). new decisions.
“We believe that the Governing Council has not ruled out the possibility of adopting measures such as raising 50 basis points (bp) to move quickly or raising the deposit rate significantly above the neutral level (1%-2%), since that the increase in inflation threatens to un-anchor inflation expectations,” says Rimeu.
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