Budapest Post

Cum Deo pro Patria et Libertate
Budapest, Europe and world news

Sharp rate rise by European Central Bank may force Bank of England to follow suit

Sharp rate rise by European Central Bank may force Bank of England to follow suit

Sky's Ian King explains that the ECB's first move against inflation, ending its era of negative interest rates, is likely to weigh on policymakers at the Bank of England next month.

An interest rate rise from the European Central Bank (ECB), its first for 11 years, was always nailed on.

Christine Lagarde, the ECB's president, had already explicitly stated in June that the bank would be increasing its main policy rate by a 0.25 percentage points this month.

But the decision took on much greater significance when, on Tuesday this week, Reuters reported - citing two sources "with direct knowledge of the debate" - that the bank's governing council would discuss a possible increase of 0.5 percentage points.

The euro surged by more than 1% against the US dollar on that news, which came just days after the single currency had fallen to below parity against the greenback for the first time in nearly 20 years.

So the only real issue was whether the ECB would raise by 25 or 50 basis points - and today it went for the latter.

It is a big, dramatic move from the ECB, which had not moved interest rates since September 2019, when it cut its main policy rate from -0.4% to -0.5%.

So interest rates in the eurozone are no longer negative for the first time in nearly three years. It reflects mounting concern across the eurozone over burgeoning inflation. Even after the Reuters report, most economists still expected only a quarter point rise. The euro rose by nearly 1% against the dollar immediately after the news.


In reality, the ECB really had very little choice. The bank, like the Bank of England, is mandated to target an inflation rate of 2% but inflationary pressures have been building up in the euro zone since the start of the year.

Consumer price inflation in the eurozone hit 8.6% in June, up from 8.1% in May, but in some eurozone countries it is already higher than that. For example, in Greece it is 12%, in Belgium it is 10.5%, in Spain it is 10% and in the Netherlands it is 9.9%.

In the Baltic states of Latvia, Lithuania and Estonia that border Russia, the rates are 19%, 20.5% and 22% respectively.

Inflation is set to increase further in coming months - producer price inflation, a good indication of where consumer price inflation is heading next, hit 32% in Germany, the eurozone's biggest and most important member, last month.

Explaining the move, the bank said: "The governing council judged that it is appropriate to take a larger first step on its policy rate normalisation path than signalled at its previous meeting. This decision is based on the governing council's updated assessment of inflation risks… it will support the return of inflation to the governing council's medium-term target by strengthening the anchoring of inflation expectations and by ensuring that demand conditions adjust to deliver its inflation target in the medium term."

The other key point of interest was whether the ECB would launch a so-called anti fragmentation tool, in the jargon.

This is a measure aimed at tackling the way that members of the eurozone have been seeing differences in their implied borrowing costs as the economic outlook deteriorates.

Investors in government bonds issued by countries perceived to be risky, such as Italy, have been demanding a premium for holding them over bonds issued by countries, like Germany, deemed less risky.

For example, the yield (or implied borrowing cost) on 10-year Italian government bonds today hit 3.7% at one point, compared with the yield of just 1.235% on 10-year German government bonds.

This has brought back memories of the eurozone debt crisis a decade ago that, at one point, threatened to overwhelm the finances of eurozone members such as Spain, Portugal, Italy, Ireland and Greece - and which prompted the ECB to launch a massive package of asset purchases (quantitative easing in the jargon).

The move prevented the euro from breaking apart. More recently, the ECB has relaunched asset purchases in response to the pandemic, but has since announced plans to halt the scheme. It is that news which has sparked these moves in government bonds - and explains the talk of an anti-fragmentation tool.

Christine Lagarde.


It was essentially seen as a way of enabling the ECB to carry on raising interest rates, in response to the take-off in inflation, without feeling inhibited by the need to prevent wider divergence between eurozone government bond yields.

This has become even more critical in the wake of Thursday morning's resignation of Mario Draghi, Ms Lagarde's predecessor at the ECB, as prime minister of Italy.

The ECB duly announced that it would be introducing an anti-fragmentation tool, which it called the transmission protection instrument (TPI).

It added: "The TPI will be an addition to the governing council's toolkit and can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area.

"The scale of TPI purchases depends on the severity of the risks facing policy transmission…by safeguarding the transmission mechanism, the TPI will allow the governing council to more effectively deliver on its price stability mandate."

The big question is whether these measures will be enough to keep inflation in the eurozone at bay and particularly in an environment in which energy prices will continue to remain at elevated levels and in which the EU is urging all member states to reduce their gas consumption by 15% - the equivalent of six weeks consumption.

Most economists and market watchers are certainly expecting further interest rate hikes in coming months.

Gurpreet Gill, macro strategist, global fixed income, at Goldman Sachs Asset Management, said: "With inflation running above 10% in nine eurozone economies, a level expected to be exceeded across the region in September and wage growth accelerating to decade highs, it is likely the ECB will deliver another 0.5% hike at its September meeting.

"Given the delicate balancing act the governing council faces due to the threat of weakening demand however, we anticipate two further less aggressive rate hikes of 0.25% in November and December."

The problem the ECB has resembles the dilemma facing the Bank of England - it is caught between raising interest rates so timidly that it guarantees further inflation and doing so in such an aggressive way that it tips the economy into a recession.

Seema Shah, chief strategist at the asset manager Principal Global Investors, said: "The ECB's era of negative rates has finally come to an end, and with quite a bang - but it's not against a backdrop of strong economic growth and certainly not accompanied by celebratory smiles.

"Quite the contrary. The ECB is hiking into a drastically slowing economy, facing a severe stagflationary shock that is quite beyond its control, while also facing an Italian political crisis which presents a difficult sovereign risk dilemma.

"There is no other developed market central bank in a worse position than the ECB."

Today's move by the ECB may also force the Bank of England itself to be more aggressive. It has to date raised its main policy rate in five consecutive meetings in a sequence that began just before Christmas last year - taking Bank rate from 0.1% to 1.25% - but only in small increments of no more than a 0.25 percentage points at a time.

Yet other central banks around the world have been raising interest rates in a more aggressive manner. The US Federal Reserve raised interest rates by 0.75 percentage points last month and is widely expected to do at least that again next week.

The central banks of Australia, New Zealand and South Korea all raised interest rates by 0.5 percentage points last week while the Bank of Canada went further still and raised interest rates by a full percentage point.

The boldness of the ECB today may leave the Bank's Monetary Policy Committee concluding that it will have to raise interest rates by at least 0.5 percentage points when it next meets on 4 August.

An increase in Bank Rate from 1.25% to 1.75% that day is now the way to bet.

Newsletter

Related Articles

0:00
0:00
Close
Unelected PM of the UK holds an emergency meeting because a candidate got voted in… which he says is a threat to democracy…
Farmers break through police barriers in Brussels.
Ukraine Arrests Father-Son Duo In Lockbit Cybercrime Bust
US Offers $15 Million For Info On Leaders Of Cybercrime Group Lockbit
Apple warns against drying iPhones with rice
Alexei Navalny: UK sanctions Russian prison chiefs after activist's death
German economy is in 'troubled waters' - ministry
In a recent High Court hearing, the U.S. argued that Julian Assange endangered lives by releasing classified information.
Tucker Carlson says Boris Johnson wants "a million dollars, in Bitcoin or cash, from Tucker Carlson to talk about Ukraine.
Russia is rebuilding capacity to destabilize European countries, new UK report warns
EU Commission wants anti-drone defenses at Brussels HQ
Von der Leyen’s 2nd-term pitch: More military might, less climate talk
EU Investigates TikTok for Child Safety Concerns
EU Launches Probe Into TikTok Over Child Protection Under Digital Content Law
EU and UK Announce Joint Effort on Migration
Ministers Confirm Proposal to Prohibit Mobile Phone Usage in English Schools
Avdiivka - Symbol Of Ukrainian Resistance Now In Control Of Russian Troops
"Historic Step": Zelensky Signs Security Pact With Germany
"Historic Step": Zelensky Signs Security Pact With Germany
Russian opposition leader Alexey Navalny has died at the Arctic prison colony
Tucker Carlson grocery shopping in Russia. This is so interesting.
France and Germany Struggle to Align on European Defense Strategy
‘A lot higher than we expected’: Russian arms production worries Europe’s war planners
Greece Legalizes Same-Sex Marriage and Adoption Rights
Russia "Very Close" To Creating Cancer Vaccines, Says Vladimir Putin
Hungarian Foreign Minister: Europeans will lose Europe, the Union's policy must change drastically
Microsoft says it caught hackers from China, Russia and Iran using its AI tools
US Rejects Putin's Ceasefire Offer in Ukraine
The Dangers of Wildfire Smoke and Self-Protection Strategies
A Londoner has been arrested for expressing his Christian beliefs.
Chinese Women Favor AI Boyfriends Over Humans
Greece must address role in migrant vessel disaster that killed 600: Amnesty
Google pledges 25 million euros to boost AI skills in Europe
Hungarian President Katalin Novák Steps Down Amid Pardon Controversy
Activist crashes Hillary Clinton's speech, calls her a 'war criminal.'
In El Salvador, the 'Trump of Latin America' stuns the world with a speech slamming woke policing after winning a landslide election
Trudeau reacts to Putin's mention of Canadian Parliament applauding a former Ukrainian Nazi in his interview with Tucker Carlson.
The Spanish police blocked the farmers protest. So the farmers went out and moved the police car out of the way.
Volodymyr Zelenskiy fires top Ukraine army commander
Tucker Carlson's interview with Vladimir Putin raises EU concerns
Finnish Airline, Finnair, is voluntarily weighing passengers to better estimate flight cargo weight
Russia's Economy Expands by 3.6% Due to Increased Military Spending
Ukraine MPs Vote To Permit Use Of Dead Soldiers' Sperm
German Princess Becomes First Aristocrat To Pose Naked On Playboy Cover
UK’s King Charles III diagnosed with cancer
EU's Ursula von der Leyen Confronts Farmer Protests Amid Land Policy Debates
Distinguishing Between Harmful AI Media and Positive AI-Generated Content: A Crucial Challenge for the EU
Tucker Carlson explains why he interviewed Putin
Dutch farmers are still protesting in the Netherlands against the government, following the World Economic Forum's call for 'owning nothing.'
Hungarian Prime Minister Viktor Orbán stands up for European farmers and says, 'Brussels is suffocating European farmers.
×