The move, which takes effect on July 27, comes as Europe battles record inflation fueled by rising energy prices. Annual inflation in the European Union jumped to 9.6% in June. It reached 8.6% for the 19 countries that use the euro. The central bank had previously said it would raise interest rates by a narrower margin, but decided it needed to be more aggressive based on an “updated assessment of inflation risk”. “Inflation remains undesirably high and is expected to remain above our target for some time,” ECB President Christine Lagarde told a news conference. The central bank refused to commit to a definitive path for a rate hike, seeking to keep its options open. “From now on we will make our monetary policy decisions based on data,” Lagarde said. “We will operate month by month and step by step. What happens in September will depend on the data we have for September.” The ECB also unveiled a new bond-buying tool aimed at keeping a lid on borrowing costs in highly indebted eurozone countries such as Italy and Greece. The central bank wants to maintain cohesion in the area that uses the single currency. The so-called Transmission Protection Facility “can be activated to address unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area,” the central bank said. The European Central Bank is ready to deploy the instrument if needed, given that countries meet certain metrics for fiscal and economic health, Lagarde stressed. “I can assure you that we would prefer not to use TPI,” he said. “But if we have to use it, we won’t hesitate.”
A web of dangers
Investors had a lukewarm reaction to the announcement. The euro, which recently hit parity with the US dollar for the first time in two decades, rose to around $1.02 after the announcement. European stocks struggled to find direction, leaving the Stoxx 600 flat. The currency’s weakness further exacerbates the inflation problem as it means European companies have to pay more for imports, including energy. The ECB is facing an upside as it steps up efforts to stop rapid price rises. Although the summer tourist season, pandemic-era savings and a strong labor market continue to support Europe’s economy, growth is slowing. The central bank is not yet in recession. In June, it said it expected output to rise 2.8 percent this year and 2.1 percent in 2023. “The base case scenario, there is no recession, not this year or next year,” Lagarde said on Thursday, although she acknowledged that the horizon is “cloudy.” Recession risks could limit the ECB’s ability to continue raising interest rates, which help fight inflation but also slow the economy. The ECB is already far behind its peers. After cutting interest rates to zero at the start of the pandemic, the Fed has been on a rate-hiking spree since March, raising its benchmark interest rate by huge increases in recent months to fight runaway inflation. Only the Bank of Japan – which on Thursday maintained its ultra-easy policies – has not budged. It also has to deal with a high degree of uncertainty about energy supplies, which makes it difficult to predict future inflation. Russia’s Gazprom resumed natural gas shipments along the critical Nord Stream 1 pipeline on Thursday, allaying fears that it will not come back online after a period of scheduled maintenance. But it is not operating at full capacity, and concern remains that Russia could shut off natural gas at some point in retaliation for Western sanctions. In addition, Europe’s third largest economy is in the midst of a political crisis that is rocking the country’s financial markets. Italian Prime Minister Mario Draghi, an investor favorite, submitted his resignation to the president on Thursday after losing the support of several key parties in his governing coalition. This may lead to early elections.
