ECB signals first rate hike in more than a decade
The strong signal of a larger interest rate hike in
September came as a hawkish surprise.
BY JOHANNA
TREECK
June 9,
2022 2:09 pm
FRANKFURT –
The European Central Bank will end its bond buys early next month and plans to
lift interest rates for the first time in over a decade by 25 basis points at
its July meeting, with inflation projected to top the central bank’s 2 percent
target until at least 2024, it said Thursday.
In a
statement released after its policymakers met in Amsterdam, the central bank
said it also “expects” to raise rates in September by a “larger increment” if
the current inflation outlook doesn’t improve. The strong signal of a larger
interest rate hike in September comes as a hawkish surprise, given that ECB
chief economist Philip Lane recently described 25-basis-point moves as
“benchmark pace.”
Eurozone
bond yields soared on the news, with yields on the benchmark German 10-year
bond hitting their highest since July 2014.
"High
inflation is a major challenge for all of us," said the ECB. "The
Governing Council will make sure that inflation returns to its 2 percent target
over the medium term."
Looking
beyond September, it said it "anticipates that a gradual but sustained
path of further increases in interest rates will be appropriate."
In a press
conference after the announcement, ECB President Christine Lagarde declined to
indicate how high interest rates may have to go. Instead, she noted the Governing
Council had decided not to discuss where it currently sees the
"neutral" interest rate, at which monetary policy neither stimulates
nor slows economic growth.
In an
unprecedented move, the ECB also published its new staff projections for growth
and inflation along with the initial policy announcement. They significantly
revised up inflation projections to 6.8 percent in 2022 and 3.5 percent in
2023, while the key medium-term inflation projection showed inflation above
target at 2.1 percent in 2024.
Of note was
that core inflation — which strips out the volatile energy and food components
that have been driving current price spikes — shows the rate above target
throughout the forecast horizon and hitting 2.3 percent in 2024.
In the
run-up to the meeting, some members were signaling that a hawkish shift might
come, with five Governing Council members expressing support for making bigger
rates hikes to rein in inflation. The new staff projections boost their case
for aggressive action to keep inflation expectations in check and stave off
higher wage demands that would fuel inflation further.
Lagarde,
for her part, cautioned that initial revisions in longer-term inflation
expectations, derived from financial markets, “warrant close monitoring.”
Hawks can
also point to the sizeable upward revision to eurozone GDP growth in the first
quarter, released Wednesday, and to the updated staff forecasts, which see
growth well above any stagflation or recessionary territory. While the forecasts
lowered the GDP outlook for this year and next to 2.8 percent and 2.1 percent,
respectively, they revised it up to 2.1 percent in 2024.
Nevertheless,
Lagarde cautioned that the “war continues to be a significant downside risk to
growth.” In case the conflict escalates and weakens demand in the medium term,
it should dampen prices, implying less need for tightening, she said.
More
broadly, Lagarde indicated that Thursday's decision didn't mark a shift away
from the central bank’s commitment to adjust policy gradually. “In times of
great uncertainty, gradualism is probably appropriate, more so than if the path
is clear, well identified, and we all understand where we are heading,” she
said.
Committed
to flexibility
Lagarde
also addressed the prospect of diverging spreads, or the difference in
borrowing costs between member states — a risk that would complicate monetary
policy transmission across the eurozone. The chance of spreads widening is on
the rise, as the ECB is winding down its bond buys as it lifts rates.
Without
offering any new details, she said the ECB was ready to act if needed to
counter widening spreads. In a sign of the increasing urgency of the issue —
which poses a test to the viability of a currency union with one monetary
policy and 19 different fiscal policies — she was constantly peppered by
questions during the press conference.
"Within
our mandate, we are committed to preventing fragmentation risks in the euro
area," she said. "Fragmented financial markets would obstruct the monetary
policy transmission and undermine the possibility for the ECB to achieve its
price stability mandate."
"The
principle is that we will not tolerate fragmentation that would impair monetary
policy," she added, by way of explaining what would trigger interventions.
"So there is no specific level of yields increase or lending rates or bond
spreads that would unconditionally trigger this or that."
The ECB
knows how to design and deploy new instruments, and if and when to use them,
Lagarde said: "We've demonstrated that in the past, we will do so
again."
However, it
remains to be seen whether the ECB under Lagarde can pull off another
"whatever it takes" moment and use the sheer weight of its
credibility to keep a lid on spreads. Nor is it clear that a tool explicitly
aimed at limiting spreads will pass the legality check of the European Court of
Justice.
Investors,
for their part, were disappointed by a lack of details on a potential new tool
to control spreads and pushed the difference between Italian and German
ten-year bonds up by 14 basis points to 222 basis points. That marks the
highest level since the early days of the pandemic, when the ECB started
vacuuming up Italian sovereign debt.
“If the ECB
says to markets: ‘we will defend Italy's spread,’ markets will for sure test
that statement,” Institute of International Finance chief economist Robin
Brooks tweeted after the press conference. “So — in effect — what the ECB did
today is to raise the odds of markets trying to force its hand.”
This story
has been updated.
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