ECB pigeons take flight as interest rates rise in July

Momentum is building for the European Central Bank to raise interest rates in July to combat skyrocketing inflation, after dovish politicians signaled they are ready to accept an end to nearly eight years of negative borrowing costs.

ECB chief economist Philip Lane and executive board member Fabio Panetta have signaled they are now more open to raising rates in coming months, following calls from governing council hawks to do the first increase in more than a decade sooner rather than later.

The hardline shift comes after eurozone inflation hit a record 7.5% in April and brings the ECB closer to the line of the Federal Reserve and the Bank of England, which raised rates this week. However, eurozone policymakers are still far behind their peers in the US and UK in the interest rate hike cycle.

The ECB has pegged borrowing costs below zero since June 2014, when it was still battling Europe’s debt crisis. The deposit rate is now minus 0.5 percent.

On Friday, the additional borrowing costs that investors are demanding to hold Italian debt over Germany’s rose above 2 percentage points for the first time since 2020, underscoring concerns that any ECB monetary policy tightening It will mainly affect the riskiest countries in the eurozone.

The so-called “spread” between the two bond yields is a closely watched barometer of investor concerns about political and economic risks in the euro zone.

For many years, the hawks have been largely outnumbered by the doves among rate setters, but skyrocketing inflation has shifted the balance of power in recent months. Lawmakers such as Vice President Luis de Guindos and Executive Board member Isabel Schnabel have said a series of rate hikes could begin as early as July. Many economists expect a 0.25 percentage point rise in the deposit rate to minus 0.25 percent at the July meeting.

Lane, seen as one of the more dovish members of the governing council that sets rates, said Thursday: “It’s clear that at some point we’re going to move rates not just once, but over time in a sequence.” Asked if this could happen in July, he told an event at the Bruegel think tank that the timing of the ECB’s first rate hike “should not be seen as the most important issue.”

“Once we start moving. . . then the whole conversation will be, ‘OK, how much are you going to make and how fast,'” he said, adding that “normalization” would mean rates rising above zero, as long as inflation stayed on track to hit 2 percent of the central bank. penny target.

The comments mark a further shift on the part of Lane, who in February was still predicting that most inflation would “disappear” within 12 to 18 months, downplaying the urgency of changing policy.

Panetta, the most dovish member of the ECB board, has continued to reject the idea of ​​raising rates at its July 21 meeting, telling La Stampa on Thursday that he should wait to see what second-quarter growth data showed. that same month. .

However, he also said that given rising inflation expectations, the ECB could “gradually reduce the level of monetary accommodation.” He added: “Under the current circumstances, negative rates and net asset purchases will no longer be necessary.”

“This is probably the time when the doves cry and capitulate under too much pressure from the hawks,” said Carsten Brzeski, head of macro research at ING. “It is fair to say that both Panetta’s and Lane’s attempts to stave off a rate hike in July were lukewarm, to say the least.”

The more centrist members of the ECB’s governing council, which includes the heads of the eurozone’s national central banks as well as members of the executive board, have also leaned toward supporting a rate hike in July.

Banque de France Governor François Villeroy de Galhau said in a speech on Friday that he “would not rule out” a rate hike at upcoming governing council meetings, adding: “Unless there are new unforeseen shocks, I think it is reasonable [for policy rates] having entered positive territory at the end of this year.”

Villeroy said the ECB needed to “carefully watch exchange rate developments” after the euro fell to a five-year low of $1.05 against the dollar, fueling inflation by pushing up import prices. “A euro that is too weak would go against our goal of price stability,” he said.

Katharina Utermöhl, an economist at Allianz, said: “Recent communications from several senior officials suggest that the ECB has already made a decision in early May on raising interest rates in July.”

Finland’s central bank chief Olli Rehn said on Thursday: “I think it would be justified to raise the deposit rate by 0.25 percentage point in July and to zero come autumn.” The ECB should go ahead with a policy tightening despite the risk of a recession in the eurozone next year, Rehn added.

“There is no need to delay the normalization of monetary policy,” Rehn told Helsingin Sanomat.

Austrian central bank chief Robert Holzmann said Thursday that the bank would “probably” raise rates at its June policy meeting.

Russia’s invasion of Ukraine and China’s coronavirus lockdowns have raised fears that Europe’s economy may suffer an economic downturn this year.

Some economists fear the ECB could tighten policy on the cusp of a recession. The last time the central bank raised rates in 2011 was just as the region’s debt crisis was starting. “Everything reminds me a lot of 2011,” said Silvia Ardagna at Barclays.

In early European trading on Friday, the gap between Italian and German bond yields reached the highest level since the depths of the coronavirus crisis in May 2020.

Italy, which has a public debt load of more than 150 percent of gross domestic product, has been a big beneficiary of the ECB’s bond purchase programs and historically low interest rates.

Additional reporting by Adam Samson in London

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