ECB braces for first interest rate hike in a decade

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The European Central Bank entered a new era on Thursday, as policymakers have made clear their intention to raise interest rates next month for the first time in more than a decade.

To prepare for this decision, the bank confirmed that it would stop expanding its bond buying program at the beginning of July.

Across the eurozone, inflation beat economists’ expectations: the annual rate of price increase soared to 8.1% in May, the highest since the euro’s inception in 1999. Policymakers have prompted to act more quickly against the inflationary forces fueled by the war in Ukraine.

“High inflation is a major challenge for all of us,” the bank said in a statement, warning that inflationary pressures had “broadened and intensified,” affecting more goods and services. Inflation, excluding food and energy prices, which tend to be more volatile, is expected to exceed the bank’s 2% inflation target through 2024.

The statement was explicit on the rate hike, saying the bank planned to raise its benchmark rate by a quarter point at its July meeting, adding that it planned to raise rates again in September. After that, there will be a “gradual but sustained path” of future increases, the bank said.

If the outlook for inflation persists or deteriorates, the bank would consider a larger rate hike in September than in July. Some policymakers had already advocated an increase of half a percentage point. Christine Lagarde, the president of the bank, will host a press conference Thursday afternoon in Amsterdam.

The central bank also updated its forecast for the economy on Thursday, painting a grim picture of rising inflation and deteriorating growth prospects as war in Ukraine disrupts trade and pushes oil prices up. energy and raw materials on the rise. This year, inflation will average 6.8%, compared to 5.1% forecast in March. The bank said the economy will grow 2.1% this year, slower than the previous forecast of 3.7%.

“Inflation will remain undesirably high for some time,” the central bank said Thursday.

The need to fight inflation outweighs concerns about a slowing economy.

The European Central Bank was slower to tighten monetary policy than other major central banks in the United States and Britain, as it expected the sharp rise in inflation to be temporary and reverse relatively quickly when energy prices stabilize. In Europe, there were also fewer signs of second-round inflationary effects, such as workers demanding large wage increases in response to rising prices.

For much of the past decade, policymakers have struggled with too low inflation. But as consumer prices began to climb and spread to more goods and services in late 2021, the bank accelerated its process of so-called policy normalization, including the possibility of raising its rate. negative interest.

On Thursday, the bank said it expected an annual inflation rate of 2.1 for 2024, above the bank’s 2% target, cementing the conditions for monetary tightening.

Right now the central bank deposit rate, which is what banks get for depositing money with the central bank overnight, is minus 0.5%, effectively a penalty intended to encourage banks to lend money rather than keep it at the central bank. The rate was first brought below zero in mid-2014 when the inflation rate fell towards zero.

As a precursor to higher rates, the bank’s bond-buying program, a way to cut borrowing costs and inject cash into the system, is set to end in early July, said the makers. (A special pandemic-era bond-buying program ended in March after 1.7 trillion euros in purchases.) This month, the bank is expected to buy 20 billion euros. mainly government bonds. The program began in 2015 and its purchases have risen and fallen as policymakers try to warm and cool the economy as needed. In May, the program’s holdings amounted to more than 3 trillion euros in bonds.

Officials will carefully monitor the borrowing costs of highly indebted countries, such as Italy, as interest rates rise. The aim is to ensure that the interest rates they pay on their bonds do not deviate too much from those of other countries in the bloc, such as Germany, in order to maintain uniformity in the costs of borrowing between countries using the common currency. The spread between Italy’s 10-year government bond yield and that of Germany widened to more than 2 percentage points, the widest since the start of 2020, when the onset of the coronavirus pandemic coronavirus has rocked financial markets.

Reinvestment of proceeds from maturing bonds could be used to avoid this so-called fragmentation. The central bank has already stressed there is flexibility in its asset purchase programs, but investors are waiting to see if the bank will provide more details on how it might react to borrowing costs. divergent.


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