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ECB Ends Net Bond Buys, Sees 25 BP Rate Hike in July

Published 09/06/2022, 13:36
© Reuters.

By Geoffrey Smith -- The European Central Bank resisted pressure to speed up its planned exit from negative interest rates on Thursday, saying that it expects to raise its key rates by only 25 basis points in July, with another hike to come in September.

As expected, the Frankfurt-based central bank also confirmed that it will formally stop its net asset purchases at the end of the month, ending a policy that has been in place for almost all of the last seven years.

With the details of its guidance - unprecedented in the degree to which it all but commits the central bank to actions three months into the future - the ECB has moved to settle a dispute over the pace of monetary tightening that has led to inconsistent messaging from the bank's top levels in recent weeks. It represents a victory for President Christine Lagarde, chief economist Philip Lane and the 'dovish' wing of the governing council over hawks who have been pressing for a half-point hike already in July.

The wording of the bank's statement, nonetheless, made a concession to its more hawkish members, by allowing for the possibility of a larger increase in September if the inflation outlook failed to improve.

"The calibration of this rate increase will depend on the updated medium-term inflation outlook," it said. "If the medium-term inflation outlook persists or deteriorates, a larger increment will be appropriate at the September meeting."

The guidance still cements the ECB's position as one of the most reluctant central banks in the world to react to the current surge in inflation. Eurozone inflation hit 8.1% in May, its highest in the 23-year lifetime of the single currency and overshooting market expectations. The promise of two small moves over the summer contrasts starkly with half-point increases in key rates in recent weeks from the Federal Reserve and the central banks of Australia, New Zealand, and India. Closer to the Eurozone, the central bank of Poland raised its key rate by 75 basis points to 6% on Wednesday.

The euro rose initially but quickly reversed after the news, and was trading little changed at $1.0727 by 7:50 AM ET (1150 GMT). Eurozone government bonds, after some initial hesitancy, sold off, as market participants zeroed in on the possibility of a total of 75 basis points of rate hikes by the end of the summer. The yield on the benchmark Italian 10-Year bond surged 16 basis points to 3.62%, its highest in eight years. The yield on its German equivalent rose 10 basis points to 1.44%, also an eight-year high.

The ECB took its decisions on the basis of updated forecasts for growth and inflation for the next couple of years. It raised its inflation forecast for 2022 from 5.1% to 6.8%, against a backdrop of surging energy prices that are now expected to stay higher for longer due to Russia's invasion of Ukraine. It expects inflation to take two years to subside to 2.1%, a touch above its medium-term target.

At the same time, the bank cut its estimates for Eurozone growth this year and next, acknowledging that the war will delay the economic recovery from the pandemic. It now expects the Eurozone economy to grow only 2.8% this year, and 2.1% in 2023. It had earlier expected 3.7% growth in 2022 and 2.8% in 2023.

The 2024 forecast was revised up marginally to 2.1%.

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