MNI STATE OF PLAY: ECB Paves Way For July, Sept Rate Hikes

The European Central Bank agreed Thursday that it would aim to raise its key interest rate for the first time since 2011 by 25 basis points in July, and said it could increase rates by a greater increment in September unless the inflation outlook moderates.

While the announcement was largely in line with expectations, the possibility of a 50-point increase in September was an acknowledgement both of inflationary pressures -- staff projections now see headline inflation at 2.1% in 2024 -- and the concerns of more hawkish policymakers.

"The Governing Council expects to raise the key ECB interest rates again in September," the decision stated. "The calibration of this rate increase will depend on the updated medium-term inflation outlook. If the medium-term inflation outlook persists or deteriorates, a larger increment will be appropriate at the September meeting."

Beyond September, the Governing Council expects that a “gradual but sustained path of further increases in interest rates will be appropriate”, ECB President Christine Lagarde said, while maintaining “data-dependence, gradualism and flexibility” throughout the normalisation process.

Members had decided not to discuss the neutral level of interest rates, she added, with a debate on the issue deferred until July or September.

FRAGMENTATION FEARS

The stage will be set for rate rises by the end of the active phase of the ECB’s Asset Purchase Programme on July 1, and Lagarde addressed fears of a blowout in peripheral bond spreads by reiterating that the ECB remains committed to the effective transmission of monetary policy across the euro area.

But peripheral bond yields rose, and Lagarde gave no details of a mooted new tool aimed at addressing potential bond market fragmentation, pointing instead to reinvestments under the ECB’s Pandemic Emergency Purchase Programme.

"We have an existing, flexible instrument - the reinvestment capacity under the PEPP - and if it is necessary we will deploy either existing adjusted instruments or new instruments that will be made available," she said.

New Eurosystem staff headline inflation projections were revised upwards to 6.8% in 2022, 3.5% in 2023 and 2.1% in 2024, with the outlook for core inflation also increasing. Growth projections were revised downwards, from 3.7% to 2.8% in 2022 and 2.8% to 2.1% in 2023.

Some governors expressed interest in looking at how the ECB can support measures needed against climate change, Lagarde said, adding that a green version of the Long-Term Refinancing Operations would be “interesting to consider,” and that reinvestment decisions might also be influenced by green concerns.