Euro Area: ECB tightens more than expected and launches new anti-fragmentation tool in July
At its 21 July meeting, the European Central Bank (ECB) hiked interest rates by 50 basis points each on the main refinancing operations (to 0.50%), the marginal lending facility (to 0.75%) and the deposit facility (to 0.00%) from their respective all-time lows. The increase, which surprised the market on the upside, ends an eight-year experiment with subzero borrowing costs, representing the first hike since 2011 as well as the largest rise since 2000—just after the Euro was created.
The Bank also unveiled a new asset purchasing program, the Transmission Protection Instrument (TPI). The tool is designed to tackle fragmentation of the Euro area bond market, avoiding surging borrowing costs for some countries and preventing another eurozone debt crisis. Under the TPI, the Bank will purchase government securities on the secondary market for countries that experience a “deterioration in financing conditions not warranted by country-specific fundamentals”.
The ECB stated that purchases under the TPI are potentially unlimited. Conditions for accessing the instrument will include compliance with the EU’s fiscal rules and recovery fund conditions, and access will also be dependent on public debt sustainability and macroeconomic policy soundness.
The twofold decision represents a balancing act between the more dovish and more hawkish members of the Governing Council: A higher-than-previously-announced hike was the price the doves had to pay for the deployment of the TPI. The decision to increase rates is aimed at tackling surging inflation even as recession risks build. Inflationary pressures have continued to intensify, as Russia’s invasion of Ukraine disrupts trade and supply chains, pushing up energy and commodity prices. Moreover, price rises have become more widespread as higher energy and production costs filter through to core consumer prices.
The Bank’s guidance was somewhat more dovish than in June, as it stated that departing from negative interest rates “allows the Governing Council to make a transition to a meeting-by-meeting approach to interest rate decisions”. Further rate hikes this year are likely—the Bank stated that at upcoming meetings “further normalisation of interest rates will be appropriate”—but the timing and size of such hikes will be contingent on the evolution of prices and the inflation outlook.
Commenting on the ECB’s decision, Carsten Brzeski, global head of macro at ING, noted:
“Today’s decision conforms with our previous view that the window for the ECB to continue with what Lagarde back in June had still called a long journey is closing fast. We expect the ECB to deliver another rate increase by a total of 50bp before winter starts. Thereafter, we currently don’t expect further rate hikes. Instead of a long rate hike journey, the ECB’s policy normalisation currently rather looks like a short trip.”
The next monetary policy meeting is scheduled for 8 September.