Final hours! Save up to 55% OFF InvestingProCLAIM SALE

ECB raises interest rates again, cuts bank subsidies

Published 10/26/2022, 06:13 PM
Updated 10/27/2022, 07:21 PM
© Reuters. FILE PHOTO: Signage is seen outside the European Central Bank (ECB) building, in Frankfurt, Germany, July 21, 2022. REUTERS/Wolfgang Rattay

By Balazs Koranyi and Francesco Canepa

FRANKFURT (Reuters) - The European Central Bank raised interest rates again on Thursday and put the reduction of its bloated balance sheet on the agenda, but said "substantial" progress had already been made in its bid to fight off a historic surge in inflation.

Worried that rapid price growth is becoming entrenched, the ECB is raising borrowing costs at the fastest pace on record. Further steps are almost certain as unwinding a decade's worth of stimulus will take it well into next year and beyond.

The central bank for the 19 countries that use the euro raised its deposit rate by a further 75 basis points to 1.5% - the highest rate since 2009. ECB rates had been negative - below 0% - for eight years until it hiked in July.

It also cut a key subsidy to banks - an attempt to force them to repay early trillions of euros' worth of ECB loans - and said detailed discussions on winding down the ECB's huge holdings of mostly government bonds will begin in December.

While the bank dropped a reference in its policy statement to likely rate hikes at "several" more meetings, ECB President Christine Lagarde appeared to revert back to this terminology.

"We will have further rate increases in the future," she told a news conference. "So it might well be several meetings."

Markets nevertheless took Lagarde's comments that a "substantial" part of policy tightening is done as a sign that rates may not go as high as previously thought.

Investors now see rates peaking at around 2.6% next year, below expectations for close to 3%, seen recently.

"We expect an additional 50 basis point policy rate hike in December, and a transition towards moving in 25 basis point increments next year as the hiking cycle pivots from policy normalisation to policy tightening," PIMCO portfolio manager Konstantin Veit said.

ECB hikes policy rate by another 75bps https://graphics.reuters.com/GLOBAL-CENTRALBANKS/xmvjkgndjpr/chart.png

Lagarde argued that the ECB may have to "go beyond" normalisation, a comment suggesting that rates may go to a level that starts restrictive economic activity.

While this neutral rate is an undefined concept, most policymakers appear to put it at roughly 1.5-2%, suggesting the ECB is now at the bottom end of the estimated range.

The euro dropped a touch on the ECB's rate announcement, while bond yields dropped sharply and bank shares rose, reinforcing views that markets had been pricing in a more hawkish decision.

Lagarde also pushed back on political criticism that rapid rate hikes threatened to push the euro zone into recession, arguing that her job was to get inflation under control.

She acknowledged that the risk of an economic contraction was on the rise due to soaring energy prices and higher rates, but said it was up to governments to support their most vulnerable citizens through the crisis.

"Everyone has to do their job. Our job is price stability," she said. "We have to do what we have to do. A central bank has to focus on its mandate."

In reaction, German Finance Minister Christian Lindner welcomed the ECB's determination to fight inflation while Italy's new economy minister Giancarlo Giorgetti said the ECB needed to take the slowdown into account.

BALANCE SHEET

With euro zone inflation hitting 9.9%, the ECB also took the first step toward shrinking its 8.8 trillion euro balance sheet, a move that is likely to raise borrowing costs further and may act as a sort of disguised rate hike.

In a move which may be fought by commercial banks, it curbed the subsidy it provides to such lenders through 2.1 trillion euros worth of ultra-cheap three-year loans called Targeted Longer-Term Refinancing Operations, or TLTROs.

The move will boost borrowing costs over the remaining lifetime of the facility, providing lenders an incentive to repay them early.

The race to raise rates https://graphics.reuters.com/GLOBAL-MARKETS/byvrloqyove/chart.png

Having borrowed at zero or even negative rates at a time when the ECB's main worry was persistently low inflation, banks can now simply park TLTRO cash with the ECB and enjoy a risk-free return that rises with each deposit rate hike.

This is politically contentious in itself, but an abundance of liquidity is also keeping money market rates depressed and preventing the ECB's rate hikes from being fully passed through via the banks to businesses and households.

Banks will now have to pay a rate equalling the deposit rate or the ECB's main refinancing rate from Nov. 23, depending on their lending performance. Both are above current market rates, which should encourage banks to repay the ECB.

© Reuters. European Central Bank (ECB) President Christine Lagarde attends a news conference following the ECB's monetary policy meeting in Frankfurt, Germany October 27, 2022. REUTERS/Wolfgang Rattay

Lagarde said the reduction of the ECB's government bond holdings was not discussed, but that a - probably fractious - debate on that topic is likely to start soon.

Lagarde said policymakers would discuss the "key principles" of how shrink the 3.3 trillion euro Asset Purchase Programme at their December policy meeting.

Latest comments

Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.