With inflation at a record high of 8.1% and continuing to rise, the ECB now fears that price growth is widening and could turn into a difficult wage-price spiral, heralding a new era of stubbornly higher prices. The central bank for the 19 countries that use the euro said it would end the quantitative easing on July 1 and then raise interest rates by 25 basis points on July 21. It will then rise again on September 8 and move further, unless the outlook for inflation improves in the meantime. Sign up now for FREE unlimited access to Reuters.com Register “We will ensure that inflation returns to the 2% target in the medium term,” ECB President Christine Lagarde told a news conference. “It’s not just a step, it’s a journey,” he said of the moves made on Thursday. The rapid rise in prices originally came from energy and food prices as economies emerged from the lockdown for COVID-19, but Russia’s invasion of Ukraine has accelerated these trends and price increases are so widespread that even and underlying inflation is running at twice the ECB target. The magnitude of interest rate hikes to curb price hikes has been hotly debated by ECB policymakers, with chief economist Philip Lane preferring 25 basis points in July and September, but others argue that 50 bps. Supporting their hypothesis, the ECB once again raised its inflation forecast, now expecting inflation at 6.8% this year compared to a previous forecast of 5.1%. In 2023, it sees inflation at 3.5% and in 2024 at 2.1%, indicating four consecutive years of inflation overruns. That’s very high, Lagarde said, adding that repeating those forecasts three months from now would require faster interest rate hikes. “If you are at 2.1% in 2024 or later, then will the increase in adjustment be greater? The answer is yes,” Lagarde said. An increase of 50 basis points, the logical next increase, would be the largest one-time increase in ECB interest rates since June 2000. At minus 0.5%, the ECB’s deposit rate has been in negative territory since 2014.
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“Given the ECB’s aggressive signals, we now expect the central bank to follow interest rate hikes by 25 basis points in July with movements of 50 basis points in both September and October,” Nordea said in a note to customers. “After that, the central bank is likely to slow down, increasing by 25 basis points in December.” Markets moved higher in price at 144 basis points by the end of this year after declaring 138 bp earlier, or an increase in every session since July, with several of these movements exceeding 25 basis points. They also expect combined movements of 240 basis points at the deposit rate by the end of 2023, setting the maximum interest rate close to 2%. Reuters Graphics Reuters Graphics “I think in times of high uncertainty, a step-by-step approach is probably more appropriate than if the route is clear, well-defined and we all understand where we are going,” said Lagarde, who just months ago said an increase in interest rates this year was extremely unlikely. Some economists have argued that the ECB was already lagging behind in tackling inflation, so raising interest rates to a neutral level, where it neither stimulates nor sustains the economy, will not be enough. “The ECB lags behind the curve,” said Commerzbank chief economist Jörg Krämer. “It’s not enough to just take his foot off the accelerator, you also have to apply the brakes,” Kramer said. “But that is exactly what it is not prepared to do, so we expect inflation to be well above 2% on average in the coming years.” The ECB’s first rate hike in more than a decade will continue to lag behind most of its global counterparts, including the US Federal Reserve and the Bank of England, which are rising sharply and promising even more action. . Unlike the Fed, the ECB also has no plans to cut its balance sheet with policymakers reaffirming their commitment to continue investing cash out of the ECB 5 5 trillion in public and private debt. Despite promising interest rate hikes, Lagarde has vowed not to allow the borrowing costs of former eurozone debt-ridden countries to rise sharply higher than financial markets. “We are committed, committed!” said Lagarde. ECB interest rates and balance sheet While the start of policy tightening is now set, the end point remains uncertain. Lagarde said interest rates should move to the neutral point where the ECB is neither simulating nor holding back growth. But this level is indefinable and unobtrusive, leaving investors to guess how far the ECB wants to go. read more Sign up now for FREE unlimited access to Reuters.com Register Additional references by Francesco Canepa in Frankfurt and Marc Jones in London. Edited by Catherine Evans and Emelia Sithole-Matarise Our role models: The Thomson Reuters Trust Principles.
