Christine Lagarde on Thursday tried to address fears that the European Central Bank was doing too little to fight record-high inflation by announcing plans to raise interest rates above zero for the first time in a decade from September.
The ECB surprised markets by signaling on Thursday after a meeting of the Amsterdam board that it was likely to raise interest rates by half a percentage point in September, in addition to the expected quarter-point increase in July.
Frederic Ducrose, head of macroeconomic research at Pictet Wealth Management, said: “They have shifted the burden of proof. Inflation needs to be improved so that it does not rise by 50 basis points. ”
Critics have accused the ECB of being behind the curve after inflation jumped to 8.1% – more than four times the central bank’s 2% target – in the year to May. The latest plans will bring eurozone monetary policymakers closer to the US Federal Reserve and the Bank of England, which have already raised interest rates several times this year. This could leave the central banks of Japan and Switzerland, as the latter two major monetary authorities still apply negative interest rates.
Lagarde and chief economist Philip Lane said earlier that raising interest rates by a quarter of a percentage point was a “benchmark” for his July and September meetings.
However, the ECB president stressed on Thursday afternoon that the risks to the inflation outlook are now “mostly up”. Central bank officials are increasingly concerned that higher wages and continued disruptions in global supply chains will exacerbate inflation.
The decision to announce the rise in July and the likely move of 50 basis points in September was unanimous, as the pigeons were happy to avoid a brighter move on the first rise of the course in exchange for a clear door opening for a bigger move in September. .
“Many of the tools we have were to raise inflation, but now we are in the opposite situation and we need to reduce it,” Lagarde said on Thursday, adding that the ECB would stay up to date and be resolved.
The bank last raised interest rates in 2011, and interest rates on its deposits now stand at minus 0.5 percent, after reaching zero in July 2012 and sinking into negative territory in 2014, when the region faced a debt crisis. .
Government borrowing costs have risen in response to the hawk shift. German 10-year bond yields rose 0.09 percentage points to 1.45%. The riskier debt sold out more sharply, with Italy’s 10-year yield rising 0.25 percentage points to 3.62%.
As planned, the bank announced it would end its remaining € 20 billion-a-month bond purchases in early July.
The ECB said in a statement that its Governing Council “intends to raise the ECB’s key interest rates by 25 basis points at its monetary policy meeting in July”. He added that if inflation forecasts remain or worsen, “a larger increase would be appropriate at the September meeting.”
After September, the ECB stated that it “expects that a gradual but sustainable path of further interest rate hikes will be appropriate”.
However, bond sales have highlighted how the ECB’s plans to abandon the stimulus of the crisis era could create problems for countries with higher debt, such as Italy.
Former ECB President and current Italian Prime Minister Mario Draghi said on Thursday before the meeting that rising inflation in the EU “is not entirely a sign of overheating, but is largely the result of a series of supply shocks.” According to him, “there is still free capacity in the economy.”
Investors, meanwhile, wanted the ECB to explain what it plans to do to avoid the risk of recurrence of financial market stress, which led to bailouts of several countries, including Greece, Portugal and Ireland, during Europe’s debt crisis in 2012. almost destroyed the single currency.
Lagarde said the ECB must ensure an end to the holding of ever-increasing amounts of government debt, and higher interest rates do not “fragment” what it costs governments and businesses in individual Member States to borrow. “We know how to design and we know how to implement new tools if and when needed,” she added. “We have demonstrated this in the past; we will do it again. ”
The President of the ECB said that the bank has full flexibility to decide when and how to deploy its anti-fragmentation instruments, including the ability to reinvest proceeds from maturities in a bond-buying scheme of 1.7 billion euros launched during the pandemic, adding: “We will prevent it.”
But she rejected requests to give more details about the circumstances that could lead to the launch of a new bond-buying instrument, saying: “There is no specific level of yield increase, or interest rates or bond spreads that could unconditionally trigger this or that. ”
The gap between Italian and German 10-year borrowing costs rose to 2.17 percentage points, the most since the early stages of the Covid-19 pandemic.
“We can almost see the hawks taking over a little bit of management at the ECB,” said Katarina Utermöll, a senior European economist at Allianz. “If there was a compromise, it was to control the hawks, not to please the pigeons.
Italian bonds have been hit by an “unpleasant combination” of the prospect of higher interest rates, along with a lack of details on any new instruments to keep a cover on government bond yields, said Richard McGuire, a strategist at Rabobank. “Since we do not know where the sore point is, this is an absolute call for pressure to build.
Lagarde said on Thursday that inflation would “remain undesirably elevated for some time” after the “unprecedented” three-quarters of the elements used to measure inflation rose by more than 2 percent last month.
The pace of price pressures in recent months has led hawks to worry that the ECB is behind the policy tightening curve and calling for more aggressive action, in line with the Fed’s strategy of raising interest rates by 50 basis points at a time. .
As Russia’s invasion of Ukraine already raises food and fuel prices for European consumers, economists are also growing fears that if Russian gas supplies are cut off, it could plunge the eurozone into recession.
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The ECB lowered its growth forecasts and sharply raised its inflation forecasts. Inflation in the euro area will rise from 2.6% last year to 6.8% this year, before falling to 3.5% next year and 2.1% next year – remaining above the 2% target for the whole forecast. period.
In March, the central bank forecast inflation of 5.1% this year, falling to 2.1% next year and 1.9% in two years.
Growth will reach 2.8% in 2022, 2.1% in each of the next two years, well below the March forecast, the report said. Carsten Brzeski, head of macro research at ING, said the forecasts were still “too optimistic, which would prevent the ECB from doing what it intends to do” to tackle inflation.
There has been speculation about how quickly the ECB could start shrinking its balance sheet by not reinvesting maturity bond proceeds in the € 4.9 trillion portfolio it has amassed. But Lagarde said the issue had not been discussed this week and would be left for a future meeting.
The Bank said such reinvestments would continue “for a long period of time after the date on which it begins to raise the ECB’s key interest rates and, in any case, for as long as is necessary to maintain sufficient liquidity and an appropriate monetary policy stance. “.
Additional reports by Amy Casmin
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