ECB raises rates by 25 bps in inflation fight
THE European Central Bank (ECB) raised interest rates by 25 basis points (bps) to 3.25 per cent as expected on Thursday (May 4) and said that it would stop reinvesting cash from maturing debt in its 3.2 trillion euro (S$4.69 trillion) Asset Purchase Programme from July.
The central bank for the 20 countries that share the euro has now lifted rates by a combined 375 bps since last July, its fastest pace of tightening.
The rate hike, a slowdown after three consecutive 50-bp increases, comes only days after eurozone banking data showed the biggest drop in loan demand in over a decade. That suggests previous rate rises are working their way through the economy and that ECB policies are now restricting growth.
ECB President Christine Lagarde signalled that more tightening would be needed to tame inflation.
“We are not pausing – that is very clear,” Lagarde told a press conference. “We know that we have more ground to cover.”
Lagarde said that there were still big upside risks to inflation, notably from recent wage deals and high corporate profit margins, and that financial conditions were still not sufficiently tight. She noted that the bank’s written statement made reference to future “policy decisions” in the plural, possibly suggesting more than one further hike.
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The ECB had said in a statement that “rate decisions will continue to be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.”
Policymakers had been split in the run up to the meeting between a 25-bp and a 50-bp rise but markets and economists had overwhelmingly bet on the smaller increase after soft data in recent weeks and similar moderation by other big central banks.
Supporting the case for a smaller move, the eurozone economy barely grew last quarter and banks were tightening access to credit, raising the risk that such a trend could morph into a full-blown credit crunch and drag further on growth.
Underlying inflation has also stopped rising – at least for the time being.
Adding to the case for caution, most big central banks around the world are now moving in 25-bp increments after big hikes earlier, and the US Federal Reserve even signalled on Wednesday that it could pause.
“Overall, the incoming information broadly supports the assessment of the medium-term inflation outlook that the Governing Council formed at its previous meeting,” said the ECB, which has missed its 2 per cent inflation target for the past decade.
But, like peers including the Bank of England, the ECB is still seen raising borrowing costs several times before a hitting peak rate of 3.75 per cent some time this summer, as inflation could take years to come back to its 2 per cent target.
Although overall inflation has fallen sharply from last autumn’s double-digit readings, underlying price pressures are still building, suggesting that price growth could level off above the ECB’s target unless the bank hikes further.
These risks are exacerbated by a tight labour market, especially since wage growth has been quicker than predicted and the jobless rate has fallen to an all-time-low despite the near-recessionary environment.
Eurozone government bond yields slipped along with the euro on Thursday after the rate hikes.
Germany’s 10-year bond yield was last roughly flat at 2.255 per cent, having traded 3 bps higher at 2.283 per cent just before the decision.
The two-year German yield, which is sensitive to interest rate expectations, slipped further and was last down 7 bps to 2.613 per cent, compared with 2.683 per cent before the decision. Yields move inversely to prices.
The euro edged lower after the decision and was last down 0.2 per cent at US$1.1039.
The STOXX 600 index maintained losses and was last down 0.9 per cent. REUTERS
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