FRANKFURT, Dec 15 (Reuters) – The European Central Bank eased the pace of its interest rate hikes on Thursday but stressed significant tightening remained ahead and laid out plans to drain cash from the financial system as part of a dogged fight against runaway inflation.
After being wrong-footed by sudden price rises, the ECB has been raising rates at an unprecedented pace. Inflation has soared since economies reopened after the COVID-19 pandemic, driven by supply bottlenecks and then surging energy costs following Russia’s invasion of Ukraine.
In a move shadowing similar steps this week by the Federal Reserve and Bank of England, it raised the rate it pays on bank deposits by 50 basis points to 2%, moving further away from a decade of ultra-easy policy. read more
That decision, which was expected, marked a slowdown in the pace of tightening from 75-basis-point increases at each of the ECB’s two previous meetings, as price pressures show some signs of peaking and a recession looms.
But with the ECB’s hikes lagging those of Fed and BoE, and its new forecasts showing inflation above the ECB’s 2% target through 2025, ECB President Christine Lagarde sought to persuade investors of its commitment to fighting higher prices.
“We judge that interest rates will still have to rise significantly and at a steady pace,” Lagarde told a news conference following its rate announcement.
“Based on the information that we have available today, that predicates another 50 basis point rise at our next meeting and possibly at the one after that, and possibly thereafter.”
Money markets immediately moved to price in a peak deposit rate of just over 3% by July, compared to 2.75% before the meeting.
But this return to giving a specific guidance on rates puzzled some ECB-watchers because it clashed with the bank’s insistence that it will take decisions “meeting-by-meeting” and depending on data.
“There is an intrinsic contradiction here no words can resolve,” said Francesco Papadia, a former top ECB official who is now a fellow at the Bruegel think tank.
Lagarde said inflation may still come in higher than the ECB expects, citing the possibility of a bout of stronger-than-expected wage growth and of a boost to demand from government support measures across the 19 euro zone countries.
The ECB statement said it currently expected any recession to be “relatively short-lived and shallow” and Lagarde noted that euro unemployment levels were at “rock-bottom”.
The euro rose above $1.07 to its highest level for nearly half a year, while the yield on Germany’s 10-year government bond hit its highest since Nov 2018 at 2.087%.
[1/2] Signage is seen outside the European Central Bank (ECB) building, in Frankfurt, Germany, July 21, 2022. REUTERS/Wolfgang Rattay
“Unlike in the U.S., we are yet to see clear signs of an easing in euro area inflation, and that could encourage the Governing Council to raise rates deeper into 2023 than the Federal Reserve – a bullish signal for the euro,” said Matthew Ryan, head of market strategy at financial services firm Ebury.
QT COMING
The ECB also laid out plans to stop replacing maturing bonds from its 5 trillion euro ($5.31 trillion) portfolio, reversing years of asset purchases that have turned the central bank into the biggest creditor of many euro zone governments.
Under the plan, it will reduce monthly reinvestments from its Asset Purchase Programme by 15 billion euros starting in March and revise the pace of balance-sheet reduction from July.
The move, which mops up liquidity from the financial system, is designed to let long-term borrowing costs rise and follows a similar step by the Fed earlier this year.
The impact was immediately felt by the euro zone’s weakest borrowers, such as the Italian government, which have come to rely on the ECB as a major buyer.
The yield on Italy’s 10-year bonds rose by 31 basis points to 4.19%, the biggest single-day change since the pandemic-induced market rout of March 2020.
“The reduction in the ECB’s balance sheet, when combined with the expected increase in bond issuance due to greater fiscal spending needs in the wake of the ongoing energy crisis, could renew upward pressure on sovereign bonds in the euro area early next year,” Daniele Antonucci, chief economist at Quintet Private Bank, said.
The ECB said it would update the market on the “the endpoint of the balance sheet normalisation” by end-2023, indicating by how much it plans to reduce liquidity in the banking sector.
This is key for determining the cost of funding for banks and therefore the interest rates for companies and households.
Thursday’s discussion is likely to have been heated after influential ECB board member Isabel Schnabel openly pushed back on the notion of smaller hikes advocated by chief economist Philip Lane.
($1 = 0.9413 euros)
Additional reporting by Yoruk Bahceli; Writing by Mark John; Editing by Catherine Evans
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