FRANKFURT, July 21 (Reuters) – The European Central Bank raised interest rates by more than expected on Thursday as concerns about runaway inflation trumped growth considerations, even while the euro zone economy reels from the impact of Russia’s war in Ukraine.
The ECB raised its benchmark deposit rate by 50 basis points to zero percent, breaking its own guidance for a 25 basis point move as it joined global peers in jacking up borrowing costs. It was the euro zone central bank’s first rate hike for 11 years.
Policymakers also agreed to provide extra help for the 19-country currency bloc’s more indebted nations – among them Italy – with a new bond purchase scheme intended to cap the rise in their borrowing costs and so limit financial fragmentation.
Ending an eight-year experiment with negative interest rates, the ECB lifted its main refinancing rate too, to 0.50%, and promised more hikes possibly as soon as its Sept. 8 meeting.
At a news conference, ECB President Christine Lagarde fielded repeated questions about how the ECB came to diverge from its original plans for tightening, and how the new yield-capping tool fitted into its core inflation-fighting mandate.
“Price pressure is spreading across more and more sectors,” Lagarde said. “We expect inflation to remain undesirably high for some time.” She listed driving factors including higher food and energy costs and wage rises.
Lagarde said ECB policymakers had unanimously decided that the increasingly evident “materialisation” of inflation risks to the economy, together with their agreement to support indebted nations if needed, justified the bigger rate hike.
“We decided on balance that it was appropriate to take a larger step towards exiting from negative interest rates.”
The ECB had for weeks guided markets to expect a 25 basis point increase but sources close to the discussion said 50 basis points was put in play shortly before the meeting as indicators pointed to a further deterioration of the inflation outlook.
With inflation already approaching double-digit territory, it is at risk of getting entrenched well above the ECB’s 2% target, with any gas shortage over the coming winter likely to push prices even higher, perpetuating rapid price growth.
Economists polled by Reuters had predicted a 25 basis point increase but most said the bank should actually hike by 50 basis points, lifting its record-low minus 0.5% deposit rate to zero.
The euro climbed as much as 0.8% to $1.0261 , having traded at $1.0198 just before the statement but turned negative on the day as Lagarde spoke.
The new bond purchase scheme, called the Transmission Protection Instrument (TPI), is intended to cap the rise in borrowing costs across the currency bloc as policy tightens.
“The scale of TPI purchases depends on the severity of the risks facing policy transmission,” the ECB said in a statement. “The TPI will ensure that the monetary policy stance is transmitted smoothly across all euro area countries.”
As ECB rates rise, borrowing costs increase disproportionately for countries like Italy, Spain or Portugal as investors demand a bigger premium to hold their debt.
“The ECB is capable of going big for that,” Lagarde said.
The ECB’s commitment on Thursday comes as a political crisis in Italy is already weighing on markets following the resignation of Prime Minister Mario Draghi, who was Lagarde’s predecessor at the ECB.
The yield spread between Italian and German 10-year bonds widened to 246.5 basis points during Lagarde’s news conference, not far from the 250 basis point level that triggered an emergency ECB policy meeting last month.
The ECB’s 50 basis point hike still leaves it lagging its global peers, particularly the U.S. Federal Reserve, which lifted rates by 75 basis points last month and is likely to move by a similar margin in July.
But the euro zone is more exposed to the war in Ukraine and a threatened cut off in gas supplies from Russia could tip the bloc into recession, leaving policymakers with a dilemma of balancing growth and inflation considerations.
Source: Reuters.com