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ECB slows rate hike but forecasts protracted fight against inflation

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ECB slows rate hike but forecasts protracted fight against inflation
Written by madishthestylebar

The headquarters of the European Central Bank (ECB) in Frankfurt

by Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters) – The European Central Bank (ECB) decided on Thursday to slow the pace of its interest rate hike but stressed that policy tightening would need to be prolonged and said it would start in March at reduce the liquidity provided to the financial system, an additional weapon in its fight against inflation.

After being taken on the wrong foot by soaring prices, the ECB began in July to raise its rates at a rate unprecedented in its history. But, following in the footsteps of the US Federal Reserve and the Bank of England among others, it has chosen to limit their rise to half a percentage point this month, compared to three quarters of a point in September and October.

Its deposit rate, the one at which it remunerates bank deposits with it, which was still negative in the spring, is thus increased from 1.5% to 2%, as expected by the markets.

Like the Fed and the BoE, the ECB has clearly hinted that further hikes will be needed before inflation falls permanently. Its new economic forecasts indeed show that the rise in prices in the euro zone could remain above its target of 2% until 2025.

“We believe that interest rates will still have to rise significantly and at a steady pace,” its president, Christine Lagarde, told a press conference, adding that rate hikes of half a point were to be expected for “a considerable period of time”.

“Based on the information we have today, this portends another 50 basis point rate hike at our next meeting, possibly at the next and possibly thereafter,” he said. -she adds.

Money markets immediately priced in this scenario and are now banking on the deposit rate peaking at just over 3% by July, from 2.75% before the meeting.

Christine Lagarde’s remarks, however, surprised some observers, who see it as a contradiction with the ECB’s rhetoric that its decisions will be taken “meeting by meeting” according to the data available.

“There is a fundamental contradiction there that words are not enough to resolve,” said Francesco Papadia, a former senior ECB official now a member of the European think tank Bruegel.

Christine Lagarde explained that the risks surrounding the outlook for inflation remained on the upside, citing the possibility of stronger than expected wage growth and that of seeing the budgetary measures to support purchasing power taken by many countries boost demand.

The press release published after the meeting of the Board of Governors evokes the possibility of a “short and weak” recession and Christine Lagarde recalled that unemployment had returned to a historically low level.

A STRONGER TONE THAN EXPECTED, WHICH DRIVES THE EURO UP

The more offensive tone than expected of the Council communiqué and the press conference allowed the euro to rise above 1.07 dollar for the first time since June.

In the bond market, the yield on ten-year German government bonds exceeded 2.08%, up more than 15 basis points on the day, and European stocks widened their losses by mid-afternoon. , the Euro Stoxx 50 index yielding 3.37%.

“Unlike in the United States, there is not yet a clear sign of an easing of inflation in the euro zone, which could encourage the Governing Council to continue raising rates in 2023 longer than the Federal Reserve. , which is a supportive factor for the euro,” said Matthew Ryan, head of market strategy at Ebury.

The next step in the tightening of the ECB’s monetary policy will be the reduction of the bond portfolio of some 5,000 billion euros built up in recent years over the purchases made by the ECB on the markets to ensure that interest rates are kept very low. .

From March, the portfolio of the APP purchase program should thus begin to shrink “at a measured and predictable pace”.

“This reduction will be 15 billion euros per month on average until the end of the second quarter of 2023, then its pace will be adjusted over time” from July, specifies the press release.

This process, which will amount to withdrawing liquidity from the financial system and which aims to promote a rise in long-term interest rates, has already been initiated by the Fed and the BoE. In particular, it will have consequences on the financing costs of banks in the euro zone, and therefore on the interest rates for loans granted to businesses and households.

The impact of these announcements was immediate on the yields of government bonds of countries considered the most fragile in the euro zone, such as Italy, which have long benefited from the purchases of the ECB: the yield on ten-year securities issued by Rome, up more than 25 points to 4.119%, was heading for its largest one-session increase since March 2020, at the very beginning of the COVID-19 crisis.

(Report Balazs Koranyi, French version Marc Angrand, edited by Blandine Hénault and Sophie Louet)

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