ECB delay portends bigger rate hikes in coming months

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A new era is about to dawn. Eurozone monetary authorities are finally ready to get proactive in tackling soaring consumer prices — but not quite yet. The European Central Bank resisted the temptation to kick off its rate hike cycle at Thursday’s Governing Council meeting. But the lockdown until the July 21 rally makes it more likely that once the first quarter-point hike is complete, the September decision will see a half-point move that will turn the benchmark deposit rate positive. for the first time in eight years. Things move fast when the tide changes.

With consumer prices rising at an annual rate of 8.1% in the Eurozone in May, it was imperative to point out that the fight against inflation starts here and now. Chairman Christine Lagarde is clearly in danger of losing control of the board, so the hawks are demanding satisfaction. The delay now means they will simply require additional, faster rides later this year.

The ECB’s forward guidance was confirmed; Just 17 days ago, Lagarde said rates would rise first in July and again in September. The central bank reiterated that commitment on Thursday, adding that the outlook for inflation will dictate the magnitude of September’s change. While the ECB now expects consumer price increases to remain above its target in 2024, the backdrop argues for the move to raise the deposit rate to 0.25% from -0.5% currently. Money markets are betting on 150 basis points of ECB rate hikes by the end of the year, which would lead to two half-point and two-quarter-point increases in the next four policy meetings.

Policymakers now face a delicate balancing act between trying to cap consumer prices without tightening financial conditions too much across the 19-nation eurozone. The ECB’s 9 trillion euro ($9.6 trillion) balance sheet is set to shrink significantly this year as it stops buying bonds. With additional bond purchases halted at the end of this month, attention will inevitably turn to when the ECB joins the Fed and the BOE in at least passively leaving its $5 trillion portfolio deplete as bonds mature. Thursday’s statement distinguishes between the original asset purchase program, which will continue for an indefinite “extended period”, and the already dormant pandemic program which will be fully reinvested until at least the end of 2024. So As pressure mounts for stimulus withdrawal, speculation will surely increase that at least the central bank could initiate quantitative tightening by halting reinvestment of buybacks sometime next year.

Banks have three opportunities this year to repay the super cheap loans the ECB has extended to them, at rates as low as -1%, under its targeted long-term refinancing operations. As expected, the special discounts available on these loans will be removed this month, bringing borrowing costs in line with the official deposit rate (which will soon increase). This will likely trigger a steady reduction in the ECB’s balance sheet over the rest of the year as commercial banks reassess their liquidity needs. This in turn risks slowing the availability of credit for the broader economy as the central bank scales back its direct monetary stimulus.

In addition, the reduction in quantitative easing will drive up borrowing costs for governments, with peripheral countries hit hardest, even as 440 billion euros annually in maturing assets are automatically reinvested, according to estimates. NatWest Group Plc analysts. The 10-year spread between Italy and Germany has widened by 50 basis points since March; the country’s benchmark yield has increased more than sixfold since August to 3.5%. With a debt-to-gross domestic product ratio of over 150%, further increases in Italy’s financing costs will raise questions about its debt sustainability.

The pandemic stimulus has clearly stayed in the financial system for too long and on too large a scale, a mistake made by central banks around the world. But the ECB is the latest to wake up to the need to step on the brakes if the inflation monster is ever to be brought under control, with more than 50 of its central bank counterparts around the world already raising interest rates. at least half a point in one step. This year.

Of course, the euro economy needs to be carefully guarded and looks more vulnerable than most. Several members of the bloc, including Germany, are already on the verge of recession. It would be a catastrophic political mistake to slide into a recession, not least because it would be a tragic waste of the trillions of euros in monetary and fiscal support for the pandemic that have been provided over the past two years.

Actions speak louder than words, so the ECB needs to reassert its credibility in the fight against inflation by pushing its deposit rate into positive territory by the end of the third quarter. After that, life gets trickier; policymakers will need to be aware of the risk of a sudden excessive tightening of financial conditions.

More from Bloomberg Opinion:

• Even a soft landing can be ugly for investors: John Authers

• Central bankers don’t know how to fight inflation: Mark Gilbert

• Memo to Fed: Hurry up and walk so we can slow down: Daniel Moss

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was Chief Market Strategist for Haitong Securities in London.

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