ECB raises rates for first time in 11 years

The European Central Bank (ECB) has raised interest rates by half a percentage point in its first increase for 11 years.

The ECB had said last month that it would raise rates by a quarter point.

But on Thursday the ECB said in a press release that it “judged that it is appropriate to take a larger first step on its policy rate normalisation path than signalled at its previous meeting” because of higher than expected inflation and the support of its new bond-buying scheme.

The ECB’s deposit rate will rise from minus 0.5% to zero while the rate on its main refinancing operations will rise from zero to 0.5% and its marginal lending facility will increase from 0.25% to 0.75%.

Policymakers also agreed to provide extra help for Euro area’s more indebted nations with a new bond purchase scheme — called the Transmission Protection Instrument (TPI) — intended to cap the rise in their borrowing costs and so limit financial fragmentation.

“The Governing Council decided to raise the three key ECB interest rates by 50 basis points and approved the Transmission Protection Instrument (TPI),” said the ECB.

“The Governing Council judged that it is appropriate to take a larger first step on its policy rate normalisation path than signalled at its previous meeting.

“This decision is based on the Governing Council’s updated assessment of inflation risks and the reinforced support provided by the TPI for the effective transmission of monetary policy.

“It 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 adjust to deliver its inflation target in the medium term.

“At the Governing Council’s upcoming meetings, further normalisation of interest rates will be appropriate.

“The frontloading today of the exit from negative interest rates allows the Governing Council to make a transition to a meeting-by-meeting approach to interest rate decisions.

“The Governing Council’s future policy rate path will continue to be data-dependent and will help to deliver on its 2% inflation target over the medium term.

“In the context of its policy normalisation, the Governing Council will evaluate options for remunerating excess liquidity holdings.

“The Governing Council assessed that the establishment of the TPI is necessary to support the effective transmission of monetary policy.

“In particular, as the Governing Council continues normalising monetary policy, the TPI will ensure that the monetary policy stance is transmitted smoothly across all euro area countries.

“The singleness of the Governing Council’s monetary policy is a precondition for the ECB to be able to deliver on its price stability mandate.

“The TPI will be an addition to the Governing Council’s toolkit and can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area.

“The scale of TPI purchases depends on the severity of the risks facing policy transmission. Purchases are not restricted ex ante.

“By safeguarding the transmission mechanism, the TPI will allow the Governing Council to more effectively deliver on its price stability mandate.

“In any event, the flexibility in reinvestments of redemptions coming due in the pandemic emergency purchase programme (PEPP) portfolio remains the first line of defence to counter risks to the transmission mechanism related to the pandemic.”

REACTION:

James Athey, investment director, Abrdn: “The ECB have belatedly and reluctantly woken up to a reality which dawned on most other central banks some time ago.

“While inflation will likely fall in the future that’s not a sufficient reason to justify maintaining an emergency stance of monetary policy today.

“However, there are no good options for them. They face a stagflation trade off which is guaranteed to make any central banker lose sleep.

“The unfurling domestic Italian political debacle merely raises the stakes and worsens the trade-off. The case for investing in European assets continues to darken.

“The market’s initial reaction reflected the surprise of a 50bp hike relative to expectations of only 25 driven by previous ECB communication.

“However in reality the market was pricing roughly 100bps over the next two meetings and the 50 hike today merely makes it more likely they do 50 again in September rather than 75.

“For that reason, the rate sell off didn’t last long, particularly as the anti-fragmentation tool details were conspicuous in their absence.”

Ben Laidler, Global Markets Strategist at social investment network eToro: “The European Central Bank (ECB) raised interest rates by a greater-than-expected 0.50% in its first hike since 2011.

“They also announced plans to contain rising government funding costs, a move given extra urgency by current Italian political turmoil.

“The case for further rate rises is clear, but the pace uncertain.

“Only Switzerland and Japan have lower interest rates than the ECB today, and Europe’s current 8.6% inflation has not yet peaked.

“But the rate hiking pace is more cautious than many as the ECB faces much tougher choices, with the continent close to recession and with intractable energy-driven inflation.

“The ECB has gone with its version of a 0.5% shock-and-awe start to its rate hiking cycle, that it hopes will anchor inflation forecasts and stabilise the Euro.

“But this rate rise is smaller than many, such as the US Fed, and is set to remain so, given the much greater policy constraints in Europe.”

Hinesh Patel, portfolio manager at Quilter Investors: “The European Central Bank has at long last joined the rate hike club with this afternoon’s 50 basis point increase – the first ECB interest rate rise for 11 years.

“The move was bigger than the 25 basis points hike the ECB had previously planned, though this comes as no surprise given runaway inflation.

“A larger rate rise was already penned in for September should the need arise and this is now all but confirmed.

“However, the ECB is pushing on a string with rate hikes that will do little to quell what is predominantly an energy crisis.

“The ECB has waited far too long relative to the Fed and the Bank of England, thereby creating additional pressure on the EUR which is adding to inflationary pressure.

“The stall in industrial activity indicates that this rate hike is likely to have minimal impact.

“Headline inflation is now creeping into core which will be gravely concerning to the ECB, especially as costs now represent the most pressing problem for corporates in the region – particularly for the likes of Italy.

“Inflation is a major issue and will be for some time yet and the balancing act faced by the ECB remains a difficult one.

“The bloc is faced with inflationary shock combined with ongoing uncertainty driven by the war in Ukraine, but the ECB’s previous inaction means today’s rate hike could well be too little too late.”

Marchel Alexandrovich, European Economist, Saltmarsh Economics:

“In the grand scheme of things it (a 50 bps hike) doesn’t change the picture. The ECB had said it wasn’t one or done, given the inflation prpojection.

“The debate in the market was if they went by 25 now and 50 bps in September. Now markets might think there could be another more 50 bps hike in September.

“We also have the Transmission Protection Instrument (TPI) and that’s going to be as important in terms of market reaction.

“It is quite vague and not what markets want to hear, it would be good to have a more transparency.”

Krishna Guha, head of policy and central bank strategy at investment bank Evercore: “The combination of a brewing giant stagflationary shock from weaponised Russian natural gas and a political crisis in Italy is about as close to a perfect storm as can be imagined for the ECB.”

About the Author

Mark McSherry
Dalriada Media LLC sites are edited by veteran news journalist Mark McSherry, a former staff editor and reporter with Reuters, Bloomberg and major newspapers including the South China Morning Post, London's Sunday Times and The Scotsman. McSherry's journalism has also appeared in The Washington Post, The Guardian, The Independent, The New York Times, London's Evening Standard and Forbes. McSherry is also a professor of journalism and communication arts in universities and colleges in New York City. Scottish-born McSherry has an MBA from the University of Edinburgh and a Certificate in Global Affairs from New York University.