European Central Bank Raises Rates for the First Time in 11 Years
On Thursday, the European Central Bank (ECB) raised interest rates in the eurozone for the first time in 11 years, as high and rising inflation becomes central bankers’ primary concern.
The 50 basis points rate hike is higher than analysts had expected, and marks a departure from the zero-interest rate environment the EU has been in since 2016.
The general consensus has been that the ECB would raise rates by 25-basis points, but a 50-point hike has in recent days been seen as increasingly likely due to soaring consumer prices in the eurozone.
"The Governing Council judged that it is appropriate to take a larger first step on its policy rate normalization path than signaled at its previous meeting," the ECB said.
ECB interest rate ahead of Thursday’s hike:
The bank also said that, at the Governing Council’s upcoming meetings, further "normalization of interest rates will be appropriate."
"The frontloading today of the exit from negative interest rates allows the Governing Council to make a transition to a meeting-by-meeting approach to interest rate decisions," they added.
For now, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 0.50%, 0.75%, and 0.00%, respectively, with effect from 27 July 2022.
Commenting ahead of the rate hike, analysts at Deutsche Bank said in a note to clients cited by CNBC that unpublished inflation expectations data may have made ECB officials worried. As a result, a 50-basis point hike has been on the table recently, they wrote.
Moreover, the analysts also pointed to the so-called anti fragmentation instrument that ECB President Christine Lagarde has been focused on recently, saying a 50-point hike would help in negotiating the details of such a tool.
The anti-fragmentation instrument was also pointed to by others, with Dirk Schumacher of financial researcher Natixis writing in a note that Lagarde is likely to stress the “temporary nature” of such an instrument.
“[…] she will also underline the ECB’s determination to secure the integrity of the monetary union, thereby trying to evoke a ‘whatever it takes’ spirit,” Schumacher wrote, adding that the fine line Lagarde needs to walk “increases the risk of a ‘misunderstanding’ and erratic market moves.”
“Anti-fragmentation” refers to work the ECB does to prevent differences in market conditions for government bonds across the eurozone from getting too large. The design of the anti-fragmentation tool is subject to intense negotiations within the ECB’s 25-member Governing Council.
The rate hike comes as the eurozone grapples with its worst inflation ever. Earlier this week, Eurostat published fresh data that showed annual inflation reached 8.6% in June. The ECB's inflation target is 2%. The central bank hopes inflation will reach its target in the "medium-term."
And although inflation in Europe remains lower than the 9.1% inflation seen in the US last month, rates in the US have been hiked to 1.75%, while the ECB has kept its rate at zero. The unwillingness to raise rates in the eurozone has led to significant weakness in the euro against the US dollar, with parity between the two major fiat currencies reached in July for the first time in 20 years.
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