Charting the course for recovery, the ECB sets the stage for rate hikes

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FRANKFURT — The European Central Bank will end years of stimulus on Thursday and signal a series of rate hikes to combat soaring inflation, leaving markets guessing at the extent and speed of policy tightening.

With inflation at a record high of 8.1% and widening rapidly, the ECB has already announced a series of measures, hoping to prevent rapid price growth from turning into a difficult wage-price spiral. to break.

Details remain elusive, however, as forecasting inflation proved impossible, suggesting that the ECB will only signal its first measures on Thursday and maintain a high degree of discretion later.

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What seems certain is that the ECB will end its long-standing asset purchase program at the end of this month, promise a rate hike on July 21 and signal that the deposit rate will move out of territory. negative in the third quarter.

Everything else, including the scale of the initial minus 0.5% rate hike, should remain open, with ECB chief Christine Lagarde emphasizing flexibility and optionality.

While the ECB’s chief economist has signaled a preference for 25 basis point hikes, inflation is rising so rapidly that sentiment could easily change over the next six weeks.

Already, several policymakers have said a bigger hike must remain in play as inflation expectations risk “unanchoring,” central banks talk as businesses and households lose faith in the bank’s willingness to control prices.

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In support of their case, new economic projections from the ECB could indicate that inflation in the 19 countries that use the euro remains above the 2% target until 2024, indicating four years consecutive overruns.

“The probability of a 50 basis point hike is increasing day by day,” said Moody’s Analytics senior economist Kamil Kovar.

“We currently view a 50 basis point hike in July as possible but unlikely. In contrast, a 50 basis point hike in September is as likely as not at this point.

“It’s even possible that the bank could resort to multiple 50 basis point hikes,” he said.

Markets are pricing in 139 basis points of rate hikes by the end of the year, an increase at every meeting from July, with some moves exceeding 25 basis points. They also predict a combined move of 230 basis points by the end of 2023.

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That leaves the ECB in a tricky 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 pushes back hard, the ECB president could signal a pledge that could become obsolete within weeks, much like the pledge not to raise rates.

The ECB’s first rate hike in more than a decade would still leave it behind most of its global peers, including the US Federal Reserve and the Bank of England, which have hiked aggressively and pledged even more stock.

“The only discussion seems to be whether the ECB should start with a 25 basis point rate hike in July or already a 50 basis point hike,” said ING economist Carsten Brzeski. .

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WHERE DOES IT STOP?

While the start of the policy tightening is now set, the end point remains uncertain.

Lagarde said rates should move closer to the neutral point at which the ECB is neither simulating nor stunting growth. But this level is indefinite and unobservable, leaving investors guessing how far the ECB wants to go.

“In our view, the ‘neutral’ rate…is around 2%,” Berenberg economist Holger Schmieding said.

“We expect the ECB’s main refinancing rate – currently 0.0% – 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 two more increases in H1 2024.”

The main refinancing rate is officially the ECB’s benchmark, but it has used its overnight deposit facility rate for banks as its main policy rate for much of the past decade, as banks have accumulated hundreds of billions of euros in excess liquidity.

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Another question is how the ECB will manage the divergence in borrowing costs of different member states.

The most indebted countries, such as Italy, Spain and Greece, have already seen a sharper increase in borrowing costs – a headache for the ECB’s single monetary policy.

While the ECB has promised to tackle “unwarranted fragmentation”, it has yet to define what it is and say what steps it will take to address it.

Lagarde could clarify these points but is unlikely to announce a specific tool at Thursday’s meeting in Amsterdam, instead emphasizing the ECB’s flexibility and commitment to act quickly in the event of market turbulence.

(Reporting by Balazs Koranyi; Editing by Catherine Evans and Emelia Sithole-Matarise)

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