ECB signals rate hike, eyes major movements in September

FRANKFURT / AMSTERDAM, June 9 (Reuters) – The European Central Bank ended a long-term stimulus scheme on Thursday, saying it would deliver its first rate hike since 2011 next month, followed by a potentially larger move in September.

With inflation at a record high of 8.1% and still rising, the ECB now fears that inflation will expand and may turn into a difficult-to-break wage-price spiral, heralding a new era of stubbornly higher prices.

The central bank of the 19 countries that use the euro said it would end quantitative easing on July 1, and then raise interest rates by 25 basis points on July 21. It will then increase again on 8 September and go for a larger move, unless the inflation outlook improves in the meantime.

“We will make sure that inflation returns to our 2% target in the medium term,” ECB President Christine Lagarde said at a news conference. “It’s not just a step, it’s a journey,” she said of the moves signaled Thursday.

Some politicians had called for a major move in July, but eventually gave in and the final political decision was approved unanimously, sources told Reuters. read more

The rapid rise in inflation was initially driven by energy and food prices as economies emerged from the COVID-19 shutdowns, but Russia’s invasion of Ukraine has accelerated these trends, and even underlying inflation is now double the ECB’s target.

The size of interest rate increases has been intensely discussed by the ECB’s decision-makers, with chief economist Philip Lane preferring 25 bp movements in July and September, while others argue that 50 bp should be considered.

In support of their case, the ECB raised its inflation estimates once again, to 6.8% for this year against an earlier forecast of 5.1%. It sees inflation of 3.5% in 2023 and 2.1% in 2024, which would be the fourth year in a row of overruns.

Lagarde said that it was too high and that similar estimates three months from now would require faster interest rate increases.

“If you are at 2.1% in 2024 or beyond, will the increase in adjustment be higher? The answer is yes,” said Lagarde.

An increase of 50 basis points, the logical next increase, will be the ECB’s largest one-time increase in interest rates since June 2000. With minus 0.5%, the ECB’s deposit rate has been in negative territory since 2014.

BEHIND THE CURVE?

“Given that our forecasts point to a further increase in core inflation in the euro area in the coming months, we now expect the ECB to raise interest rates by 25bp in July, and by 50bp in September,” said Pictet strategist Frederik Ducrozet.

“We expect the ECB to return to the ‘reference rate’ of 25bp increases, but they are likely to increase in October and December, and the 50bp option is likely to remain on the table until core inflation declines significantly.”

Late on Thursday, the markets priced in 144 basis points with interest rate increases this year, which indicates an increase at each meeting from July, with several features of over 25 basis points.

They predicted a total movement of 240 basis points in the deposit rate by the end of 2023, which put the interest rate peak close to 2%.

“I think in times of great uncertainty, gradual is probably appropriate, more so if the path is clear, well-identified and we all understand where we are going,” said Lagarde, who earlier this year said an interest rate hike in 2022 was highly unlikely. .

Some economists have argued that the ECB was already too late in tackling inflation, so it will not be enough to raise interest rates to the neutral level, where it neither stimulates nor holds back the economy.

“ESB stays behind the curve,” said Commerzbank’s chief economist Jörg Krämer.

“It is not enough to just take your foot off the gas, it must also step on the brake,” said Krämer. “But that’s exactly what it’s not prepared to do, and that’s why we expect inflation to average well above 2% in the next few years.”

The ECB’s first rate hike in over a decade will still leave it behind most of its global counterparts, including the US Federal Reserve and the Bank of England, which have increased aggressively and promise even more action.

Unlike the Fed, the ECB also has no plans to reduce its balance sheet, and decision-makers reaffirm their commitment to continue reinvesting cash maturing from the ECB’s 5 trillion euro debt.

Even when she promised interest rate increases, Lagarde promised not to let the borrowing costs of former debt crisis countries in the eurozone be pushed sharply higher by the financial markets again. “We are engaged, engaged!” in Lagarde. [nL1N2XW1BX]

While the start of the policy tightening has now been set, the end point is still uncertain.

While Lagarde has said that interest rates should move towards the neutral point, this level is undefined and unobservable, which allows investors to guess how far the ECB wants to go. read more

Further reporting by Francesco Canepa in Frankfurt and Marc Jones in London; Edited by Catherine Evans

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