The European Central Bank is about to raise interest rates for the first time in 11 years, joining peers around the world in confronting a historic spike in inflation after months of standing on the sidelines.
With soaring prices an ever-growing concern for households, companies and governments across the 19-nation euro zone, the ECB may even deviate from guidance by considering a hike of double the planned quarter-point at Thursday’s meeting.
News of it discussing such a step prompted ABN Amro to change its prediction to 50 basis points from 25. Money markets put the likelihood of each at 50%.
Whatever the size, the move is set to be flanked by the presentation of a new instrument to contain debt-market jitters as borrowing costs are lifted. The exact make-up of the bond-buying tool is likely to go down to the wire as officials tangle over conditions for countries benefiting from the purchases.
While the ECB’s long-awaited rate liftoff brings it closer to the more than 80 central banks that have already raised this year, it still trails the likes of the Federal Reserve, which began hiking in March and opted most recently for a jumbo 75 basis-point increase.
See also: ECB delivers landmark rate cut but few signals top
What’s more, just as it gets underway, the case for caution is stacking up. While the immediate threat of economic chaos triggered by a cut-off of Russian gas was deferred on Thursday with flows via the Nord Stream pipeline resuming, recession risks in Europe remain high and will be amplified if Moscow halts winter energy supplies.
Elsewhere, a political crisis in Italy -- where Prime Minister Mario Draghi is expected to resign this morning -- showed how quickly government-bond markets can become unnerved, while the euro recently slipped to parity with the US dollar, feeding record inflation that’s four times the 2% target.
What Bloomberg Economics Says...
“Progress on the ECB’s anti-fragmentation tool could determine whether we get the 25 basis-point hike telegraphed in June or the 50 basis points the Governing Council is now considering. Our view remains that a truly credible solution to fragmentation is only likely to emerge in the midst of a crisis -- that points to an underwhelming announcement and a smaller rate hike.”--Jamie Rush, Chief Europe Economist. For full preview, click here
See also: ECB holds rates and signals cuts are still some way off
Following a revamp of the decision-day timetable, the ECB’s initial statement will come at 2.15 pm in Frankfurt -- 30 minutes later than before. President Christine Lagarde’s briefing will start at 2.45 pm -- 15 minutes later.
Interest Rates
When the Governing Council met in June, it made an unusual commitment to lift its deposit rate by a quarter-point this month to -0.25%. It pencilled in a bigger move at the next meeting in September, if the inflation outlook doesn’t improve, advocating a “sustained path of further increases” beyond that.
In the runup to this week’s announcement, however, policy makers have had second thoughts and are now weighing a hike of 50 basis points, according to people familiar with their discussions. That would end eight years of negative rates in one go, as well as topping all but four predictions in a Bloomberg poll of 53 economists.
The reason for the more hawkish debate is inflation, which hit a fresh record in June. Despite the economic headwinds, analysts say price gains have yet to peak. Officials fret that expectations may become de-anchored, stoked by potential natural gas shortages, even if an economic downturn ensues.
Fragmentation Tool
A crucial part of the ECB’s ability to accelerate rate hikes will be the effectiveness of measures designed to contain the fallout.
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A bond-market wobble after the Governing Council’s last policy meeting prompted officials to speed up work on what they’ve so far dubbed the Transmission Protection Mechanism -- part of a two-pronged defense that also includes flexible reinvestments from the ECB’s pandemic bond portfolio.
The new tool is needed, they say, so their inflation-fighting efforts aren’t derailed by unwarranted swings in government-debt yields. First, though, the Governing Council’s 25 members must agree on its design, with a failure to unveil anything bound to disappoint investors.
Italy’s political storm has raised the risk of speculative attacks. That’s driven the spread between 10-year government bonds and their German counterparts past 200 basis points, fueling fears the ECB’s instrument may be needed sooner than expected.
Some analysts worry the tool won’t be nimble enough to shore up bond markets, with officials keen for it to look like a backstop for emergencies rather than a rescue measure for governments facing political turmoil or poor economic fundamentals.
