The ECB raises interest rates more than the flag in the race to curb inflation

  • All courses increase by 50 basis points
  • Inflation remains “undesirably” high
  • The ECB supports “anti-fragmentation” tool called TPI
  • The ECB “can go big” on that, says Lagarde

FRANKFURT, July 21 (Reuters) – The European Central Bank raised interest rates by more than expected on Thursday as concerns about current inflation outperformed concerns about growth, even as the eurozone economy suffers from the effects of Russia’s war in Ukraine.

The ECB raised its reference deposit rate by 50 basis points to zero percent, breaking its own guidance for a 25 basis point movement when it joined forces with global counterparts to increase borrowing costs. It was the ECB’s first rate hike in 11 years.

Politicians also agreed to provide extra aid to the more indebted nations of the 19-nation currency bloc – Italy among them – with a new bond-buying scheme intended to limit the increase in their borrowing costs and thus limit financial fragmentation.

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After concluding an eight-year experiment with negative interest rates, the ECB also raised its key refinancing rate to 0.50%, promising more increases, possibly as soon as the September 8 meeting, and more to follow later.

ECB President Christine Lagarde said a clear deterioration in the inflation outlook and unanimous support for the anti-fragmentation instrument justified the larger move.

“Price pressure is spreading to more and more sectors,” said Lagarde. “We expect inflation to remain undesirably high for some time.” She listed driving factors including higher food and energy costs and wage increases.

“All in all, we decided that it would be appropriate to take a bigger step towards getting out of negative interest rates.”

But even though the ECB is now moving faster, Lagarde said, the terminal interest rate – or the level at which the increases end – has not changed.

The ECB did not provide guidance for its expected rate hike in September, saying only that further increases would be appropriate and decisions would be made face-to-face.

The ECB had for several weeks guided the markets to expect a 25 basis point increase on Thursday, but sources close to the discussion said that 50 basis points came into play shortly before the meeting as part of an agreement including aid to indebted countries.

With inflation already approaching double-digit territory, it is in danger of being anchored well above the ECB’s 2% target, with any gas shortages over the coming winter likely to push prices even higher, and maintain rapid inflation.

Lagarde warned that the risk to the inflation outlook was on the upside and has intensified, especially as the war is likely to drag on and keep energy prices high for longer.

Economists asked by Reuters had predicted an increase of 25 basis points, but most favored an increase of 50 basis points, which lifted the ECB’s record low minus 0.5% deposit rate to zero. read more

The euro climbed as much as 0.8% to $ 1.0261, after trading at $ 1.0198 just before the statement, but turned negative on the day Lagarde spoke. The markets are now pricing in an interest rate increase of almost 50 basis points in September and see a total of 124 basis points rising for the rest of the year.


The new bond purchase scheme, called the Transmission Protection Instrument (TPI), is intended to limit the increase in borrowing costs across the entire currency block as the policy tightens.

“The extent of TPI purchases depends on the severity of the risks facing political transmission,” the ECB said in a statement. “The TPI will ensure that monetary policy is transferred evenly across all euro area countries.”

As ECB interest rates rise, borrowing costs increase disproportionately for countries such as Italy, Spain or Portugal as investors demand a larger premium to keep their debt.

“The ECB is capable of going big for that,” Lagarde said.

Activation of the instrument will be entirely within the ECB’s discretion, and the bank will target bonds in the public sector with maturities between one and 10 years.

Countries will be eligible if they comply with EU fiscal rules and do not face “serious macroeconomic imbalances”. Compliance with obligations under the EU Recovery and Resilience Facility will be necessary, and there will also be a need for an assessment of current sustainability.

The ECB’s commitment on Thursday comes as a political crisis in Italy is already weighing on markets after Prime Minister Mario Draghi, Lagarde’s predecessor in the ECB, resigned.

The yield spread between Italian and German 10-year bonds rose to 246.5 basis points during Lagarde’s press conference, not far from the 250 basis point level that triggered an ECB crisis meeting last month.

The ECB’s rise of 50 basis points means that it remains behind its global competitors, especially the US Federal Reserve, which raised interest 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 the war in Ukraine, and a threatened disruption in gas supplies from Russia could tip the bloc into recession, leaving decision-makers with a dilemma of balancing growth and inflation concerns.

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Author by Mark John; Edited by Toby Chopra, John Stonestreet and Catherine Evans

Our standards: Thomson Reuters Trust Principles.

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