The ECB has decided to surprise and speed up the process of monetary normalization to quell runaway inflation, even if it slows economic growth. For the first time in 11 years, the Christine Lagarde-led institution has hiked rates by 50 basis points, the largest hike in 22 years. Thus, the interest rate in the eurozone is 0.5%, while the interest rate on the marginal lending facility reaches 0.75% and the deposit facility comes out of negative territory – it was -0.5% – and at 0.00% lies. .
Lagarde yesterday acknowledged that the institution’s board of directors discussed the pros and cons of raising interest rates above the 25 basis points announced in June and unanimously decided to go a step further and keep interest rates negative. The President of the ECB pointed out that many indicators have changed over the past month and risks have materialized that would affect the transmission of monetary normalization.
The institution yesterday confirmed that it remains firmly committed to restoring price stability to ensure inflation returns to its medium-term target of 2%. The Governing Council deems it appropriate to take “a first step on its path towards normalizing key interest rates that is more significant than what was hinted at at its last meeting”.
He assured that “additional rate normalization will be appropriate” but gave no details on what the new hikes will look like from September. A decision that breaks the mantra of the forward guidance that has been in place for the last decade and that “allows the Governing Council to move to an approach where interest rate decisions are made at each meeting,” as the bank’s head office explained.
“We’re much more flexible in the sense that we don’t provide any foresight,” Lagarde said. The ECB is thus ensuring that the future development of interest rates will continue to depend on this data
with the aim of revealing that inflation will return to 2% in the medium term. It also states that the ECB Governing Council will examine the possibility of remuneration for excess liquidity as part of the normalization of its policies.
The ECB met market expectations and unveiled its new tool, the Transmission Protection Instrument (TPI), to avoid fragmentation of risk premia. An announcement that comes at a time when the resignation of Italian Prime Minister Mario Draghi has put peripheral risk premia under renewed pressure. Italian debt rose 15 basis points to 3.5%, while the transalpine risk premium closed at 232 basis points, a little off its year highs of 242. More stable was Spanish 10-year debt, which closed steady at 2.5% after moments of turbulence a premium of 126 basis points, 10 points below the high of 136 hit in mid-June.
The TPI will be unlimited and, according to Lagarde, will be due to all eurozone countries suffering from disordered and unwarranted market dynamics that pose a serious threat to the transmission of monetary policy in the community club.
Of course, its activation requires the unanimous approval of the Governing Council and the country’s compliance with various criteria. The central bank points out that its main weapon to stop the rise in government debt yields is reinvestment of maturities of the anti-pandemic PEPP purchase program.
The TPI, he explains, will be added to the rest of the Governing Council’s tools and can be activated “to counter unwanted or disorderly market dynamics that pose a serious threat to the transmission of monetary policy in the euro area as a whole.” Regarding the amount of purchases it will make, the ECB warns that it will depend “on the severity of the risks to policy transfer” and ensures no prior limits have been placed on the purchases. The new instrument will thus enable the ECB to fulfill its mandate to maintain price stability more effectively.
The central bank also notes that it will continue to fully reinvest the capital of APP maturities maturing “for a long time” to maintain conditions for ample liquidity and appropriate monetary policy orientation. Regarding the maturities of the PEPP, the Governing Council estimates that the principal amount will be reinvested at least until the end of 2024.
Christine Lagarde’s increased aggressiveness served the euro for a few minutes to regain some of its lost brilliance. After rising 0.8% to $1,028 on Lagarde’s words, a lack of details on the future of monetary policy dampened gains. At market close, the European currency was exchanged for 1,018 greenbacks. The single currency rallied 2.84% from last week’s lows.
The Vice President of the European Central Bank, Luis de Guindos, did not want to comment on the announcement of a bank tax in Spain. “It’s difficult to give an opinion without knowing the details of the tax. We don’t know the details and our opinion cannot be complete,” he said at the press conference after the Governing Council meeting. Guindos insisted on recalling that the institution had previously defended the need for this type of measure in order not to hamper lending or tighten financing conditions or affect the sector’s solvency.