The European Central Bank surprises markets with larger-than-expected interest rate hikes,

The European Central Bank is raising interest rates for the first time in 11 years. But in Italy, the political unrest is back.

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On Thursday, the European Central Bank raised interest rates for the first time in 11 years in an attempt to cool down violent inflation in the eurozone.

The ECB, the central bank of the 1[ads1]9 nations that share the euro currency, surprised the markets by pushing the reference rate up by 50 basis points and bringing the deposit rate to zero. Economists had expected a small increase of 25 basis points.

“The Governing Council considered it appropriate to take a larger first step on its policy rate normalization path than signaled at the previous meeting,” the ECB said in a statement on Thursday.

The Frankfurt institution had kept its courses at historically low levels, in negative territory since 2014, when it dealt with the region’s sovereign debt crisis and the coronavirus pandemic.

The euro rose to an increased high on news of the more aggressive rate hike, trading at $ 1.0257. The yield on the 10-year Italian bond also jumped on the news, expanding gains after reacting to the departure of Prime Minister Mario Draghi earlier on Thursday.

Higher interest rates by 50 basis points and softer future guidelines show that the ECB believes that the window for a series of interest rate increases will close quickly.

Carsten Brzeski

global macro manager at ING Germany

The ECB also said that this interest rate movement “will support the return of inflation to the Governing Council’s medium – term target by strengthening the anchoring of inflation expectations and by ensuring that demand conditions adapt to delivering the inflation target over the medium term.” The central bank’s inflation target is 2%.

The ECB had previously signaled that it would raise interest rates in July and September as consumer prices continue to rise, but it was unclear whether it would go so far as to bring interest rates back to zero. The ECB’s deposit rate is now 0%, the main interest rate for refinancing operations is 0.5% and the marginal lending facility is 0.75%.

Seema Shah, chief strategist at Principal Global Investors, said in an email that the ECB was not tightening its policy against a backdrop of strong economic growth “and certainly not accompanied by festive smiles”.

“The ECB is heading for a drastically declining economy, and is facing severe stagflation [when inflation is high and growth is low] shock that is quite beyond its control, while facing an Italian political crisis that presents a difficult sovereign risk dilemma, “she said, adding” there is no other central bank in a developed market in a worse position than the ECB. “

Carsten Brzeski, global macro manager at ING Germany, said: “For the first time since 2011, the bank has raised interest rates and done so with a bang. Interest rate hikes with 50 basis points and softer future guidance show that the ECB believes the window for a series of rate hikes closes quickly.”

Rising inflation

A first reading for inflation in June showed a record high of 8.6%. However, some investors are skeptical of the ECB’s actions as they predict a recession later this year. Back in June, the ECB’s forecasts pointed to an inflation rate of 6.8% for the whole of this year, and 3.5% in 2023. In terms of growth, the central bank estimates a GDP rate of 2.1% for this year and next.

One of the biggest uncertainties ahead is whether Russia will cut off natural gas supplies to Europe completely. Moscow has been accused of arming fossil fuels while the EU imposes harsh sanctions on the Kremlin for its unprovoked attacks in Ukraine.

Natural gas flows have fallen by around 60% since June, and a critical pipeline, Nord Stream 1, saw supplies resume on Thursday after maintenance – albeit with reduced capacity.

European Economic Commissioner Paolo Gentiloni has said that a complete cut in supplies from Moscow, with Europe so dependent on Russian hydrocarbons, could push the eurozone into a recession this year, although this is not the EU’s basic scenario at the moment.

Anti-fragmentation tool

Meanwhile on Thursday, investors kept a close eye on details regarding the ECB’s new anti-fragmentation tool, which is aimed at supporting nations with high debt, such as Italy.

The central bank called this new tool TPI (Transmission Protection Instrument). It can be activated to counter “unjustified, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area,” it said.

“The extent of TPI purchases depends on the severity of the risks facing political transfers,” the ECB added, adding that further details would be released at 14:45 London time on Thursday.

The expectations point to some conditions between implementing strict domestic reforms and qualifying for this new instrument. This will be especially important in the context of Italian politics, where a short-term election is now expected in the autumn after Prime Minister Mario Draghi resigned on Thursday morning.

A credible government that adheres to the goals agreed with the European Commission will be critical if it is to benefit from the new tool.

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