interest rate hike by the European Central Bank

Thursday the European Central Bank (ECB) raised interest rates in the euro area for the first time in 11 years, with high and rising inflation becoming the central banks’ main concern.

Source: Adobe / JFL Photography

The 50 basis point increase in interest rates is higher than analysts had expected, marking a break from the zero interest rate environment in which the EU has found itself since 2016.

The general consensus was that the ECB would raise interest rates by 25 basis points, but an increase of 50 basis points has in recent days been seen as more and more likely due to rising consumer prices in the euro area.

“The Governing Council considered it appropriate to take a larger first step towards normalizing its key interest rate than indicated at its previous meeting,” the ECB said.

Developments in ECB interest rates before rising on Thursday:

The bank also said further “normalization of interest rates will be appropriate at future board meetings.”

For the time being, the interest rates on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 0.50%, 0.75% and 0.00% respectively, with effect from 27 July 2022.

In anticipation of rising interest rates, analysts German bank said in a note to customers quoted by CNBC that unpublished data on inflation expectations may have worried ECB officials. As a result, a 50 basis point increase was considered recently, they wrote.

In addition, analysts also highlighted the implementation of the anti-fragmentation instrument, which the President of the ECB, Christine Lagardefocused and says that a 50 bp increase would help negotiate the details of such a tool.

The anti-fragmentation instrument has also been highlighted by others, Dirk Schumacher by the financial researcher Natixis writes in a note that Lagarde is likely to emphasize the “temporary nature” of such an instrument.

“[…] it will also underline the ECB’s willingness to guarantee the integrity of monetary union and thus seek to evoke the need to do what needs to be done, Mr Schumacher wrote, adding that the fragile balance that Mrs Lagarde must respect “increases the risk of a ‘misunderstanding’ and erratic market movements. “

“Anti-fragmentation” refers to the work done by the ECB to prevent the differences between the market conditions of euro area government bonds from becoming too great. The design of the anti-fragmentation tool is the subject of intense negotiations in the 25-member Governing Council of the ECB.

The rate hike comes as the eurozone struggles with the worst inflation in its history. Start of the week, Eurostat released new data indicating that annual inflation hit 8.6% in June. The ECB’s inflation target is 2%. The central bank hopes that inflation will reach its “medium-term” target.

And while inflation in Europe remains lower than the 9.1% seen in the US last month, US interest rates were raised to 1.75% while the ECB kept its interest rate at zero. The reluctance to raise interest rates in the euro area has led to a significant weakness in the euro against the US dollar, as parity between the two major fiat currencies was reached in July for the first time in 20 years.

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