After an 11-year Hiatus: The ECB will finally Join the Banks in Raising Rates

EU | July 21, 2022, Thursday // 11:15|  views

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The European Central Bank will raise interest rates today for the first time in 11 years, with a more decisive change of half a percentage point (50 basis points) most likely as policymakers fear losing control of rampant growth of consumer prices.

Inflation, which is already approaching double-digit territory in the Eurozone, is now at risk of anchoring well above the ECB's target of 2% a year. Avoiding that scenario requires raising interest rates, even if it slows — or collapses — an economy already suffering from the effects of Russia's war on Ukraine.

But the ECB board appears to be far from united on how fast the bank should move, with some arguing that it is already far behind the curve, especially compared to global peers such as the US Federal Reserve. Others point to a looming recession that the ECB risks exacerbating if it is not careful.

The bank had until recently signaled a hike of just 25 basis points, to be followed by a bigger hike in September. But sources close to the discussion told Reuters that a 50 basis point hike would also be on the table on Thursday as the outlook for inflation quickly worsened.

Economists polled by the agency had forecast an increase of just 25 basis points, but most said the base should actually rise by 50 basis points, lifting its record low deposit rate from minus 0.5 percent to zero.

Complicating the decision, the recent fall in the euro's exchange rate to a 20-year low against the dollar is also adding to inflationary pressures, adding to the case for more interest rate hikes, even if that ultimately hurts growth.

However, a larger increase would require the ECB to protect more indebted nations such as Italy or Spain from a spike in borrowing costs. So a deal on a new bond-buying scheme will also be needed, which sources say is already close to being agreed.

When interest rates rise, borrowing costs on the bloc's periphery often rise disproportionately, and the ECB has promised to combat this kind of fragmentation with a new tool.

While not all details are expected to be announced, ECB President Christine Lagarde is likely to make a firm commitment and should offer financial markets at least some details, including on the requirements to trigger ECB aid.

In June, when she made only a vague commitment, investors immediately challenged the ECB, pushing yields on Italian debt to their highest in a decade. This forced the ECB to call an emergency meeting and announce a stronger commitment.

Markets currently see a rate move of almost 100 basis points through September and a combined 170 basis point hikes through the end of the year. That equates to increases in all of the next four meetings, with multiple increments of 50 basis points each.

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Tags: interest rates, ECB, POINTS, rise


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