ECB To Hike Rates For First Time In Over A Decade

The European Central Bank is set to deliver the first hike in interest rates in 11 years on Thursday, and follow up with another such move in September, and may also provide guidance on the proposed anti-fragmentation tool.

Economists widely expect the Governing Council to raise rates by 25 basis points, as the bank announced in June.

That said, many are not ruling out a bigger than expected 50 basis points hike as the euro area inflation keeps setting new records, and many signs of slowing economic growth have surfaced recently.

Some economists also pointed out that the ECB may opt for a catching-up act with a half-point hike in July as policymakers could be dealing with a recession by the September policy session that would leave little wiggle room for more tightening.

ING economist Carsten Brzeski said the very gradual and cautious normalization process the ECB started at the end of last year has “simply been too slow and too late”.

This week, the euro fell below parity versus the dollar for the first time in two decades. A weakening euro exchange rate adds to the already ‘undesirably’ high inflationary pressures through imported inflation, and thus puts more pressure on ECB policymakers to act aggressively.

In June, ECB President Christine Lagarde had said policymakers would opt for a bigger 50 basis point hike in September if the macroeconomic outlook worsened.

Minutes of the June policy session showed that calls were already made for an interest rate hike then.

“We expect the hawks to give it another try to push for a front-loading of rate normalization…,” Brzeski said.

“It will be a balancing act between the ECB’s credibility as being predictable and its credibility as a determined inflation fighter.”

The main refinancing rate currently stands at zero, the deposit facility rate at -0.50 percent and the lending rate is at 0.25 percent.

Eurozone interest rates were last raised in July 2011.

The ECB is scheduled to announce its latest policy decision at 08:15 AM ET on Thursday. ECB President Lagarde and Vice-President Luis de Guindos are set to hold the post-decision press conference at 08:45 AM ET.

Inflation in the euro area set a new record high of 8.6 percent in June, way above the ECB’s target of 2 percent, though the core measure eased slightly, thanks to a temporary slowing in energy price rise.

Both the ECB and the European Commission have raised Eurozone inflation forecasts and lowered the growth outlook as the Russian gas crisis and consequent high inflation hurts economic activity in the single currency bloc.

Citing an entrenchment of inflationary pressures, Capital Economics predicted that the ECB could raise rates by 50 basis points at each of its policy meetings in September, October and December before lifting the deposit rate to a peak of 2.0 percent around the middle of next year.

The political crisis in Italy has put the focus back on the need for an anti-fragmentation tool.

The research firm does not expect the Governing Council to agree all the finer details of a new anti-fragmentation tool in the latest policy session, but to do so later on.

“So we anticipate further bond market volatility but not a re-run of the full-blown eurozone crisis, and we have penciled in new bond purchases, starting later this year,” Capital Economics economist Andrew Kenningham said.

ING’s Brzeski expects the hawkish policymakers to try negotiate a trade-off between front-loading rate hikes and the strictness of conditionality in the new tool, i.e. front-loading against looser conditions.

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