The ECB raised its key deposit rate by 50 basis points to zero percent, breaking its own guidance for a 25 basis point move, as it joined global peers in raising borrowing costs. It was the ECB’s first rate hike in 11 years. Policymakers also agreed to provide additional aid to the most indebted sovereigns of the 19 countries – including Italy – with a new bond-buying plan aimed at curbing the rise in their borrowing costs and thereby curbing financial fragmentation. Sign up now for FREE unlimited access to Reuters.com Register Ending an eight-year experiment with negative interest rates, the ECB also raised its key refinancing rate to 0.50% and promised more hikes, possibly as soon as its Sept. 8 meeting, with others to follow later. ECB President Christine Lagarde said a clear deterioration in the inflation outlook and unanimous support for the anti-fragmentation instrument justified the bigger move. “Price pressure is spreading across more and more sectors,” Lagarde said. “We expect inflation to remain undesirably high for some time.” She listed driving factors as higher food and energy costs and wage increases. “We decided overall that it was appropriate to take a bigger step towards exiting negative interest rates.” But even if the ECB is now moving faster, Lagarde said, the final rate – or the level at which hikes end – has not changed. The ECB did not provide guidance on an expected rate hike in September, saying only that further hikes would be appropriate and decisions would be made on a meeting-by-meeting basis. The ECB had for weeks been guiding markets to expect a 25 basis point hike on Thursday, but sources close to the discussion said 50 basis points came into play just before the meeting as part of a deal that includes aid for indebted countries. With inflation already nearing double-digit territory, it risks anchoring well above the ECB’s 2% target, with any gas shortages in the coming winter likely to push prices even higher, perpetuating rapid price increases. Lagarde warned that risks to the inflation outlook are upside and have intensified, particularly as the war is likely to continue, keeping energy prices high for longer. Economists polled by Reuters had forecast a 25 basis point hike, but most favored a 50 basis point hike, taking the ECB’s record low minus 0.5 percent deposit rate to zero. read more The euro climbed as much as 0.8% to $1.0261, having traded at $1.0198 shortly before the statement, but turned negative on the day Lagarde spoke. Markets are now pricing in a nearly 50 basis point rate hike in September and a combined 124 basis point hikes for the rest of the year.
IS IT GOING BIG?
The new bond-buying system, called the Transmission Protection Instrument (TPI), is intended to limit the rise in borrowing costs across the currency bloc as policy tightens. “The scale of TPI purchases depends on the severity of risks facing policy transmission,” the ECB said in a statement. “The TPI will ensure that the direction of monetary policy is transmitted smoothly across all euro area countries.” As ECB interest rates rise, borrowing costs rise disproportionately for countries such as Italy, Spain or Portugal, as investors demand a higher premium to hold their debt. “The ECB is capable of taking big steps on this,” Lagarde said. Triggering the instrument will be entirely at the ECB’s discretion and the bank will target public sector bonds with maturities between one and 10 years. Countries will be eligible if they comply with European Union fiscal rules and do not face “severe macroeconomic imbalances”. Compliance with commitments under the EU’s Recovery and Resilience Facility will be needed, as well as an assessment of debt sustainability. The ECB’s commitment on Thursday comes as a political crisis in Italy is already weighing on markets following the resignation of Prime Minister Mario Draghi, who was Lagarde’s predecessor at the ECB. The yield spread between Italian and German 10-year bonds widened to 246.5 basis points during Lagarde’s press conference, not far from the 250 basis point level that prompted an emergency ECB policy meeting last month. The ECB’s 50 basis point hike still leaves it trailing globally, particularly the US Federal Reserve, which raised interest rates by 75 basis points last month and is likely to move by a similar margin in July. However, the euro zone is more exposed to the war in Ukraine and a threatened cut in gas supplies from Russia could push the bloc into recession, leaving policymakers with a dilemma of balancing growth and inflation. Sign up now for FREE unlimited access to Reuters.com Register Is Mark John writing? Editing by Toby Chopra, John Stonestreet and Catherine Evans Our Standards: The Thomson Reuters Trust Principles.
