The ECB prepares for its first interest rate hike in a decade

On Thursday, the European Central Bank will enter a new era as policymakers confirm how soon its bond purchase program will end and reaffirm plans to raise interest rates over the summer for the first time in more than a decade. .

Across the eurozone, inflation has exceeded economists’ expectations: The the annual rate of price increase rose to 8.1 percent in Maythe highest since the creation of the euro in 1999. Politicians have been pressured to act faster against the inflationary forces fueled by the war in Ukraine.

The central bank will also provide updated forecasts for the economy on Thursday, which are likely to paint a bleak picture of rising inflation and worsening growth prospects. Last month, the European Commission lowered its economic growth forecast to 2.7% for this year, from 4% estimated in the winter, and said inflation would average 6.8% for the year. year.

But the need to tackle inflation is outweighing concerns about an economic slowdown.

For much of the past decade, politicians have struggled with too low inflation. But as consumer prices began to rise and spread to more goods and services in late 2021, the bank accelerated its process of so-called policy normalization, including the possibility of raising its negative interest rate. The inflation forecast for 2024 will be a crucial signal that medium-term inflation should be at or above the bank’s 2% target, further consolidating conditions for monetary tightening.

At the end of May, Christine Lagarde, the bank’s president, outlined the expected path for interest rate hikes in unusually clear terms, reporting hikes in July and September. “Based on the current outlook, it is likely that we will be able to get out of negative interest rates by the end of the third quarter,” Ms. Lagarde wrote in a blog post. The bank’s more aggressive tone also helped raise the euro from the five-year minimum against the dollar in recent weeks. Mrs Lagarde will conduct a press conference in Amsterdam on Thursday afternoon.

At the moment, the central bank deposit rate, which is what banks receive for depositing money with the central bank overnight, is minus 0.5 percent, effectively a penalty intended to encourage banks to lend money. rather than keep it at the central bank The rate was first cut below zero in mid-2014 when the inflation rate dropped towards zero.

Traders will listen carefully for clues as to the magnitude of potential rate hikes. Financial markets are currently betting on the deposit rate to rise more than 130 basis points, or 1.3 percentage points, by the end of the year.

The central bank chief economist recently said that increases are likely to be a quarter of a percentage point at a time, but some policy makers have suggested that a larger than normal increase of half a percentage point might be justified.

Bank of America analysts expect the central bank to raise interest rates by 1.5 percentage points this year. “The pressure to move faster (and less gradually) will continue to build from here,” they wrote in a note to customers.

As a forerunner of the rate hike, the bank’s bond purchase program, a way to keep borrowing costs low and inject money into the system, is expected to end in early July, policymakers reported. (A special pandemic-era bond purchase program ended in March after € 1.7 trillion in purchases.) The bank will buy € 20 billion primarily in government bonds this month. The program began in 2015, and its purchases have grown and decreased as policymakers have tried to heat and cool the economy as needed. As of May, holdings in the program amounted to over € 3 trillion in bonds.

But even if the bank stops growing its asset purchase programs, officials will be watching closely the borrowing costs of countries with a high debt burden as interest rates rise. The aim is to ensure that their debt yields do not diverge too much from those of other bloc countries, such as Germany. This year, the spread between the Spanish 10-year government bond yield and the German one has grown to 113 basis points from 70 basis points.

The reinvestment of the proceeds of maturing bonds could be used to avoid this so-called fragmentation. The central bank has already pointed out that there is flexibility in its asset purchase programs, but investors are waiting to see if the bank will provide more details on how it could respond to diverging financing costs.