The ECB’s Governing Council has decided to raise the three key ECB interest rates by 50 basis points, and at the same time approved the Transmission Protection Instrument. This follows the strong commitment of the Governing Council’s to make sure inflation returns to its 2% target over the medium term. The decision has been made after the assessment made by the body on the inflation risks.
The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 0.50%, 0.75% and 0.00% respectively, with effect from 27 July 2022, the Governing Council has announced.
Christine Lagarde, President of the European Central Bank has appeared at the press conference together with the Vice President Luis de Guindos and stated that the Governing Council had judged that it was appropriate to take a larger first step on its policy rate normalisation path and so the council decision was based on their updated assessment of inflation risks and the reinforced support provided by the TPI for the effective transmission of monetary policy.
Commenting on this decision Paul Diggle, Deputy Chief Economist at abrdn said that the ECB was becoming the latest central bank to signal a smaller rate hike, and then deliver a bigger one on the day, and in his opinion the monetary policy statement made clear that further hikes are coming, probably in 50bps increments. He also comments on the anti-fragmentation tool, which has been called the Transmission Protection Instrument (TPI). As he continues, purchases under the TPI he says, are unlimited and the markets will like it.
“The doves and hawks on the Governing Council had reached a quid pro quo”Paul Diggle, Deputy Chief Economist at abrdn
The Deputy Chief Economist also says that one possibility is that the doves and hawks on the Governing Council had reached a quid pro quo, and a large hike was traded off for a bigger Transmission Protection Instrument. On the other hand, he continues, there is still the need to see the details of the TPI and the conditionality support that comes with.
Wolfgang Bauer, Fund Manager at M&G’s Public Fixed Income Team, has also commented on the news saying that the ECB had ended the era of negative interest rates in Europe today. With inflation running hot, the ECB decided to frontload the process of normalising monetary policy with a 0.5% hike.
He continues saying that the ECB moved rates up twice as much as they had communicated at their June meeting, showing with this is the severity of the current inflation dynamics. This, in his opinion, is is meant as a signal to market participants that the ECB is committed to reining in inflation. However, he says, despite today’s rate hike, the ECB is still deploying a distinctly more accommodative monetary policy than other major central banks, and the 0.5% hike was only a first step towards interest rate normalisation, therefore if inflation continues to reign supreme, there is still a lot of catching-up to do.
“The ECB is still deploying a distinctly more accommodative monetary policy than other major central banks.”Wolfgang Bauer, Fund Manager at M&G’s Public Fixed Income Team
For Andrew Mulliner, Portfolio Manager at Janus Henderson One surprising element of the announcement was that the ECB will look to offset any purchases with some kind of sterilisation to ensure the purchases don’t interfere with the monetary policy setting, and so this sterilisation will not be just with regards to the level of liquidity in the system but also the aggregate size of the monetary policy debt security portfolio, in his opinion this might indicate that the ECB could seek to reduce its allocation to core bonds as part of this program.
“We should expect substantial negative revisions from the ECB staff at the next forecast round, and makes the remark that stagflation is a nightmarish environment for a central bank with responsibility for 19 different countries.”Andrew Mulliner, Portfolio Manager at Janus Henderson
He thinks that the acknowledgement of the challenging growth outlook alongside the inflation outlook, marks a more nuanced take than perhaps has been notable from the ECB at prior press conferences. Mulliner believes that we should expect substantial negative revisions from the ECB staff at the next forecast round, and makes the remark that stagflation is a nightmarish environment for a central bank with responsibility for 19 different countries.
Another one on commenting has been Sebastian Vismara, senior economist, BNY Mellon Investment Management, who believes that the combination of an imperfect “anti-fragmentation” tool, and a further Russia-provoked negative energy shock could push headline inflation up further. An he thinks that in such a scenario, the ECB may be faced with a stark choice.
Vismara says that either, the bank keeps tightening amid a recession, severely hitting growth, bringing down headline inflation in the near-term, or the ECB implicitly accepts elevated inflation for years without much monetary tightening, as it finds itself unable to effectively contain rising financial stability risks stemming from higher rates and debt sustainability concerns in periphery euro area countries.
“The combination of an imperfect “anti-fragmentation” tool, and a further Russia-provoked negative energy shock could push headline inflation up further.”Sebastian Vismara, senior economist, BNY Mellon Investment Management
He thinks that in such a scenario, the ECB will choose to hike rates in a recession and improve the “anti-fragmentation” tool if needed, but we remain mindful about the latter risk.
Morganne Delledonne, Head of Investment Strategy Europe de Global X says that the decision made by the ECB was widely unexpected given the political turmoil in Italy, the widening of core versus peripheral bond spreads, and the drop in business sentiment across the region and mostly in Germany. For her it looks like a desperate last opportunity to raise interest rates before the region falls into a recession in the fall, and believes that across Europe, and particularly in Italy, sustained inflation starts creating political instability.
“It looks like a desperate last opportunity to raise interest rates before the region falls into a recession in the fall.”Morganne Delledonne, Head of Investment Strategy Europe de Global X
Delledonne recognises this is a very challenging time for the ECB which obviously does whatever it takes to combat inflation and anchor in inflation expectations even at the risk of precipitating a recession.