ECB to stop buying bonds; to increase interest rate by 25 basis points in July

10 Jun 2022 , 01:05 PM

 The European Central Bank (ECB) has announced the end of a long-running stimulus program and hinted at a series of rate rises beginning in September if the inflation outlook does not improve.
 
ECB announced a 25 basis point rate rise in July
 
With inflation at an all-time high of 8.1 % and climbing, the ECB is concerned that price increase is widening and might transform into a difficult-to-break wage-price spiral, ushering in a new era of higher prices after a decade of anemic growth.
 
The European Central Bank said that it will stop buying bonds on July 1 and hike interest rates by 25 basis points later that month.
 
“At its July monetary policy meeting, the Governing Council aims to raise key ECB interest rates by 25 basis points,” the ECB stated.
 
“The Governing Council intends to raise key ECB interest rates once again in September,” the statement stated. “If the medium-term inflation forecast remains unchanged or worsens, a greater increase at the September meeting will be necessary.”
 
Energy prices first drove the quick rise in inflation, but now food and service expenses are also growing.
 
The number of rate hikes to slow inflation has been hotly contested by ECB policymakers, with Chief Economist Philip Lane favoring 25-basis-point increases in July and September, while others argue that 50-basis-point increases should be considered.
 
In support of their position, the ECB boosted its inflation forecasts again further, now forecasting 6.8% inflation this year, up from 5.1 % previously. Inflation is expected to be 3.5 % in 2023 and 2.1 % in 2024, suggesting four years of inflation overshoots.
 
“The Governing Council expects a modest but sustained path of additional interest rate hikes to be appropriate,” it stated.
 
“For all of us, high inflation is a huge concern. Over the medium term, the Governing Council will ensure that inflation returns to its objective of 2% ‘In the medium term,’ the ECB stated.
 
Markets expect 139 basis points of rate rises by the end of the year, or an increase at each meeting beginning in July, with some movements exceeding 25 basis points.
 
By the end of 2023, they expect a total of 230 basis points of movement in the deposit rate, placing the interest rate peak close to 2%.
 
This puts Lagarde in a difficult position on Thursday, only months after she suggested a rate rise this year was improbable. If she ignores the markets, even more, aggressive tightening might be priced in, resulting in excessively higher borrowing prices. However, if she pushes back hard enough, the ECB president may announce a commitment that will be outmoded in weeks, similar to the no rate hike guarantee.
 
The ECB’s first-rate rise in nearly a decade will still put it behind most of its global rivals, particularly the Federal Reserve of the United States and the Bank of England, who have been hiking rates quickly and promised much more action.
 
The ECB, unlike the Fed, has no intentions to decrease its balance sheet, with policymakers confirming their resolve to continue reinvesting funds maturing from the ECB’s 5 trillion euros in public and private debt.
 
Where does it end?
 
While the beginning of policy tightening has been determined, the final point is yet unknown. According to Lagarde, rates should rise toward a neutral position where the ECB is neither stimulating nor inhibiting growth. However, because this threshold is undefined and unobservable, investors are left wondering how far the ECB is willing to go.
 
Another concern is how the ECB will deal with member states’ differing borrowing rates. The ECB’s one-size-fits-all monetary policy has already caused rates on government bonds to increase more quickly in countries with higher debt stacks, such as Italy, Spain, and Greece, than in less-indebted Germany or France.