FRANKFURT – The European Central Bank (ECB) will pull the plug on several years of stimulus on Thursday and signal a series of rate hikes to combat rising inflation so markets will only guess the size and pace of tightening.
With inflation at a record high of 8.1% and expanding rapidly, the ECB has already marked a series of movements in hopes of halting rapid inflation in developing into a hard-to-break wage-price spiral.
However, the details are still elusive as it has proved impossible to predict inflation, suggesting that the ECB will only signal its first steps on Thursday and maintain plenty of discretion further down.
What seems certain is that the ECB will end its long-term asset buyback program by the end of this month, promise a rate hike on July 21 and signal that deposit rates will be out of negative territory in the third quarter.
Everything else, including the magnitude of the initial rate hike from minus 0.5%, is likely to remain open, with ECB President Christine Lagarde emphasizing flexibility and freedom of choice.
While the bank has signaled a preference for increases of 25 basis points, the energy-driven rise in prices may change that in a few weeks. A handful of policy makers have already said a major increase should remain in play.
In support of their case, new economic projections from the ECB are likely to indicate that inflation across the 19 countries using the euro will stay above its 2% target by 2024, pointing to four consecutive years of overruns.
“The probability of an increase of 50 basis points is increasing day by day,” said Moody’s Analytics senior economist Kamil Kovar.
“We are currently seeing an increase of 50 basis points in July as possible, but unlikely. In contrast, an increase of 50 basis points in September is as likely as it is at this time.”
“It is even possible that the bank will resort to more increases of 50 basis points,” he said.
Markets price 135 basis points of rate hikes at the end of this year, or an increase at each July meeting, with some of the movements above 25 basis points.
That leaves the ECB in a difficult position, a few months after Mrs Lagarde said a rate hike this year was highly unlikely.
If she ignores the markets, even more aggressive austerity measures could be priced, unnecessarily pushing up borrowing costs. But if she pushes back sharply, the ECB president could signal a commitment that could become obsolete within a few weeks, as well as the promise of no rate hike.
The ECB’s first rate hike in over a decade would still leave it behind most of its global peers, including the US Federal Reserve and the Bank of England, which have raised aggressively and promise even more action.
“The hawkish focal point begins,” Bank of America said in a note. “We expect the ECB to leave the door open to 50 basis points in July and September by signaling that negative interest rates will end during the third quarter.”
WHERE DOES IT END?
While the start of the austerity measures has now been set, the end point remains uncertain.
Ms. Lagarde has said that interest rates should move towards the neutral point where the ECB neither simulates nor holds back growth. But this level is undefined and unobservable, leaving investors guessing how far the ECB wants to go.
“In our opinion, the ‘neutral’ interest rate is around 2%,” said Berenberg economist Holger Schmieding.
“We expect the ECB’s primary refinancing rate – currently 0.0% – to reach this level by mid-2024 following three 25 basis point rate hikes in the second half of 2022, three such movements in 2023 and two further increases in the first half. of 2024. ”
The primary refinancing rate is formally the ECB’s benchmark, but it has used interest rates on its day-to-day bank deposit facilities as its primary interest rate for most of the last decade, as banks have accumulated excess liquidity of hundreds of billions of euros.
Another question is how the ECB will deal with the divergence in borrowing costs in different Member States.
Nations with larger debt piles, such as Italy, Spain and Greece, have already seen a sharp rise in borrowing costs – a headache for the ECB’s uniform monetary policy.
While the ECB promised to combat “unjustified fragmentation”, it has not yet defined unjustified and has not said what it will take to tackle it.
Mrs Lagarde could clarify these points, but she will hardly announce a specific tool on Thursday, emphasizing instead the ECB’s flexibility and commitment to act quickly in the event of marketsuro. – Reuters
