Recklessly late, it hiked a lot faster than forecasters even imagined a few months ago: 125 basis points in two meetings and promising more.
By Wolf Richter for WOLF STREET.
The ECB announced today that it would hike its three policy rates by 75 basis points, bringing its deposit rate from 0% to +0.75%, thereby ending the era of Zero Interest Rate Policy (ZIRP). This is the biggest rate hike since 1998, at the very beginning of the monetary union, when countries still used their local currencies.
At its meeting in July, the ECB had ended its Negative Interest Rate Policy (NIRP) by hiking its policy rates by 50 basis points, its first rate hike since 2011, and the biggest since June 2000. The rate hike brought its deposit rate up from -0.5% to 0.0%. Both those terms – ZIRP and NIRP – have become expressions of central-bank induced financial absurdity.
And the ECB is shocked, shocked, to find that inflation is going on here, and so there will be more rate hikes “over the next several meetings” because “inflation remains far too high and is likely to stay above target for an extended period,” and the ECB needs “to dampen demand and guard against the risk of a persistent upward shift in inflation expectations.”
Effective September 14, the ECB will hike its:
- Deposit rate, from 0.0% currently, to 0.75%. RIP ZIRP.
- Main refinancing rate, from 0.5% currently, to 1.25%
- Marginal lending rate, from 0.75% currently, to 1.50%.
QE is over.
The ECB confirmed today that QE was over. Its Asset Purchase Program (APP) and its Pandemic Emergency Purchase Program (PEPP) will maintain their current balances, and replace maturing securities with new securities.
The balances of its “targeted longer-term refinancing operations” (TLTRO III) with banks have dropped as loans have matured. The ECB said that it “will continue to monitor bank funding conditions and ensure that the maturing of operations [under TLTRO III] “does not hamper the smooth transmission of its monetary policy.”
Recklessly late, but moving a lot faster than imagined a few months ago.
QE finally ended. NIRP, the greatest absurdity of all, finally ended. And now ZIRP finally ended. But with overall inflation at 9.1% and the policy rate at 0.75%, the ECB is still throwing lots of fuel on the inflation fire, making it the most reckless of the major central banks.
But it has moved a lot faster – hiking by 125 basis points over two meetings – than people had predicted just a few months ago. Back then, forecasters saw one or two timid hikes of 25 basis points this year, bringing its deposit rate to maybe 0% by the end of 2022. Turns out, its deposit rate may well be over 2% by the end of this year, which seemed like an unimaginably high rate just a few months ago.
Inflation started surging in March 2021 and exploded this year.
Inflation in the Eurozone, similar to inflation in the US, started surging in early 2021, nearly a year before the war in Ukraine. In July 2021, it blew past the ECB’s target. In February 2022, it hit 5.9%. And then it went from there to 9.1% in six months, a record in the Eurozone data going back to 1997.
For most of this time, the ECB vigorously brushed off the inflation. It’s just over the past few months that it gradually started taking inflation seriously.
What is now transpiring in the Eurozone is runaway inflation, with CPI hitting 25.2% in Estonia, and with nine of the 19 Eurozone countries experiencing double-digit inflation. It’s a horror show, despite national governments throwing many billions of euros at all kinds of subsidies and tax holidays that lower energy retail prices, transportation prices, and other items.
ECB acknowledges: Inflation is spreading, including into services.
Inflation is a big theme in the ECB’s statement. “Price pressures have continued to strengthen and broaden across the economy and inflation may rise further in the near term,” it said.
The ECB has “significantly revised up” its inflation projections, despite the tightening of monetary policies and the “substantial slowdown” in economic growth:
- 2022: 8.1%
- 2023: 5.5%
- 2024: 2.3%
Energy prices that started surging across Europe in early 2021 and this year have exploded.
Inflation less energy, food, alcohol, and tobacco products jumped from 2.3% in January to 4.3% in August. And inflation in services jumped from 2.3% in January to 3.8% in August.
Energy prices will eventually come back down by at least by some amount, but inflation in services, which is a big part of the economy, is particularly hard to get back under control.
“Energy is still, of course, the main source of inflation,” ECB president Christine Lagarde said at the press conference, “but we also have an inflation that spreads across a larger range of sectors.”
Glue gun in hand.
“The Transmission Protection Instrument is available to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across all euro area countries, thus allowing the Governing Council to more effectively deliver on its price stability mandate,” the ECB said in the statement.
This TPI is the glue gun to keep the Eurozone together. Its purpose is to allow the ECB to hike rates and to tighten, while keeping the spread between, say, German government yields and Italian government yields, from blowing out and triggering another sovereign debt crisis.
Under this program, the ECB can target the bonds that it allows to roll off the balance sheet, and the bonds that it buys, based on yields in the fiscally weaker countries. For example, if the spread between German and Italian yields begins to blow out, it can let maturing German bonds roll off its balance sheet while buying a similar amount of Italian bonds.
The hope is that the mere existence of the tool will keep markets in line so that the ECB won’t even need to use the tool all that much.
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.