Europe’s central bank to hike rates in July, 1st in 11 years

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Amsterdam:  The European Central Bank on Thursday said it would carry out its first interest rate increase in 11 years in July, followed by another hike in September.

The bank made the surprise move, saying that inflation had become a “major challenge” and that inflationary forces had “broadened and intensified”.

The bank is making a sharp turn from supporting the economy during the COVID-19 pandemic to squelching inflation that has hit record levels in the 19 countries that use the euro. It also said will end its economic stimulus program next month.

The pivot underlines concerns about the level of annual consumer price increases, which hit 8.1 per cent in May. The bank’s target is 2 per cent.

The European Central Bank is expected on Thursday to end a key economic stimulus programme and map out its plan to raise interest rates for the first time in more than a decade as it seeks to join the US Federal Reserve and other central banks in tackling high inflation. But it’s a delicate balance to not further slow economic growth.

Markets will parse remarks from President Christine Lagarde for clues about how far the bank will go in making credit more expensive in the 19 countries using the euro currency.

That is because the meeting likely also will lay out a sharp downgrade to the bank’s forecasts for economic growth as Russia’s war in Ukraine sends shock waves through the global economy.

Some bank officials have called for more drastic rate hikes of a half-percentage point instead of the more usual quarter-point, as the Federal Reserve did last month. Lagarde has stressed that bringing interest rates to more normal levels after the recession from the COVID-19 pandemic must be done gradually, with Europe more exposed to the fallout from the war in Ukraine.

Lagarde and other top officials have been unusually explicit about the bank’s plans. They have indicated in blog posts and interviews that Thursday’s meeting in Amsterdam will put an end to the bank’s remaining bond purchases, which propped up the economy during the pandemic and aimed to raise years of abnormally low inflation, as well as set up the bank’s first rate increases in 11 years at its July and September meetings.

Carsten Brzeski, global head of Macro at ING bank, called those remarks a “de facto pre-announcement.”

A rate increase as soon as Thursday isn’t impossible but would upend the bank’s promise that it would first end bond purchases, which drive down the cost of longer-term government borrowing, and only then turn to raising interest rates.

The ECB trails other central banks worldwide that have used rate hikes to target surging consumer prices following the rebound from the pandemic and worsened as Russia’s invasion of Ukraine drove up food and energy prices. The Fed raised rates in May for the first time since 2000, and the Bank of England has approved hikes four times since December.

Higher rates are the usual tool to combat inflation, which hit 8.1 per cent in the eurozone in May, the highest since statistics started in 1997. By raising its benchmarks, the central bank can influence what financial institutions, companies, consumers and governments have to pay to borrow the money they need. So higher rates can help cool off an overheating economy.

But higher rates can also weigh on growth. That makes the ECB’s job a delicate balance between snuffing out inflation and blunting economic activity. The bank’s goal is to keep inflation at 2 per cent, the rate considered best for the economy.

The World Bank on Tuesday cut its outlook for global economic growth this year to 2.9 per cent from 4.1 per cent predicted in January. For the eurozone, it downgraded expected growth to 2.5 per cent from 4.2 per cent.

Low interest rates were aimed at raising protracted low rates of inflation that bank officials attributed to multiple factors such aging populations, the pressure on wages from company’s ability to move jobs to cheaper countries and even online shopping that enables more price comparison.

Those concerns seem like ancient history as high oil and natural gas prices fed by Russia’s invasion have sent inflation rates drastically higher.

An ECB move to attack on inflation has raised concerns about the impact of higher interest rates on heavily indebted governments, most notably Italy. Market watchers have speculated that the bank may announce a new bond purchase program that it could hold in reserve to prevent borrowing costs from spiking in any one EU country.

A rate hike in July would be the first in 11 years and signal the end of an extended period of extremely low rates that started during the global financial crisis in 2009.

The bank’s expected increases would start from record lows of zero for its lending rate to banks and minus 0.5 per cent on overnight deposits from banks.

The European Central Bank is headquartered in Frankfurt, Germany, but holds occasional meetings in other EU capitals to underline its status as a pan-European institution.

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