The European Central Bank (ECB) will pull the plug on years of stimulus on Thursday and signal a rate hike to fight rising inflation, leaving the market only to speculate on the size and pace of policy.
With inflation at a record high 8.1 percent and widening rapidly, the ECB has already taken a number of steps, hoping to prevent rapid price increases from turning into a hard-to-break wage-price spiral.
Details remain elusive, however, inflation has proven impossible to predict, suggesting the ECB will only signal its opening moves on Thursday and exercise a lot of discretion down the line.
What appears certain is that the ECB will end its long-running asset purchase program at the end of this month, promising a rate hike on July 21 and indicating that deposit rates may turn negative sometime in the third quarter. will be out of the area.
Everything else, including a zero to 0.5 percent increase in the initial rate, could be left open, with ECB chief Christine Lagarde emphasizing flexibility and optionality.
While the ECB’s own chief economist has indicated a preference for a 25-basis-point increase, inflation is rising so quickly that sentiment could easily change over the next six weeks.
Already, many policy makers have said a bigger increase was needed to play out because inflation expectations were at risk of “de-anchoring,” central bank speak, when businesses and households are at risk of bankruptcies to rein in prices. Lose faith in desire.
Supporting their case, the ECB’s new economic projections may indicate that inflation in the 19 countries that use the euro is above the 2 percent target by 2024, pointing to four consecutive years of overshooting.
“The prospect of a 50 basis point increase is increasing day by day,” said Kamil Kovar, senior economist at Moody’s Analytics.
“We currently see a 50-basis-point increase in July as possible but unlikely. In contrast, a 50-basis-point increase in September is just as likely as it is unlikely at this point.”
“It is also possible that the bank will resort to multiple 50-basis-point increases,” he said.
Markets are increasing rates by 139 basis points through the end of this year, or more than 25 basis points in each meeting since July, with some moves. They are also forecasting a move to a combined 230 basis points by the end of 2023.
This leaves the ECB in a difficult position, just months after Lagarde said a rate hike this year was highly unlikely.
If it ignores the markets, even more aggressive tightening could be priced in, unnecessarily raising borrowing costs. But if she backs down strongly, the ECB president could signal a commitment that could be obsolete within weeks, much like a pledge to hike rates.
The ECB’s first rate hike in more than a decade will still outpace most of its global peers, including the US Federal Reserve and the Bank of England, which are aggressively lifting and promising even more action .
ING economist Carsten Brzewski said, “It seems that whether the ECB should start with an increase of 25 basis points in July or an increase of 50 basis points already in place.”
Where does it end?
While the start of policy tightening is now set, the final point remains uncertain.
Lagarde has said that rates should move towards a neutral point at which the ECB is neither emulating nor stunting growth. But this level is undefined and imperceptible, allowing investors to gauge how far the ECB wants to go.
“In our view, the ‘neutral’ rate … is about 2 percent,” said Bernberg economist Holger Schmiding.
“We expect the ECB’s core refinancing rate – currently 0.0 percent – to reach this level in mid-2024 after three rate hikes of 25 basis points in the second half of 2022, three such moves in 2023 and the first half. Two more increases in 2024.”
The prime refinancing rate is formally the ECB’s benchmark, but it has used the rate on its overnight deposit facilities for banks as its main policy rate over the past decade, noting that banks have accumulated hundreds of billions of euros of excess liquidity. piled up.
Another question is how the ECB will handle the difference in borrowing costs of different member states.
Large-debt nations such as Italy, Spain and Greece have already seen sharp increases in borrowing costs – a headache for the ECB’s one-size-fits-all monetary policy.
While the ECB promised to fight “unnecessary fragmentation”, it has not yet defined unfair and has not said what action it will take to deal with it.
Lagarde could clarify these points, but she is unlikely to announce a specific tool at Thursday’s meeting in Amsterdam, instead emphasizing the ECB’s resilience and commitment to act quickly in the face of market turmoil. gives.