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FRANKFURT — The European Central Bank (ECB) slowed the pace of its rate hikes on Thursday, but stressed significant tightening is still ahead and unveiled plans to pull cash out of the financial system as part of a dogged fight against runaway inflation.
After being caught flat-footed by sudden price hikes, the ECB has hiked rates at an unprecedented pace. Inflation has skyrocketed since economies reopened after the 2019 coronavirus disease (COVID-19) pandemic, driven by supply shortages and then rising energy costs following Russia’s invasion of Ukraine.
In a move shadowing similar moves by the Federal Reserve and Bank of England (BoE) this week, it raised the rate it pays on bank deposits by 50 basis points to 2%, moving further away from a decade of ultra-loose policy .
That decision, which was expected, marked a slowdown in the pace of tightening from 75 basis points of hikes at each of the ECB’s previous two meetings as price pressures show some signs of peaking and a looming recession.
But to get a majority for that slowdown, ECB President Christine Lagarde had to make a promise to dissenters that rates would be hiked again, potentially up to three times, by the same amount, sources told Reuters.
“Based on the information available to us today, this points to a further 50 basis point rise at our next meeting and possibly the one after and possibly thereafter,” Ms Lagarde said at a news conference following the rate announcement.
Money markets immediately priced in a top deposit rate of just over 3% through July, down from 2.75% before the meeting.
The ECB is pushing hard to convince investors of their obligation to fight higher prices after lagging the Fed and BoE on rate hikes.
But this return to specific guidance on interest rates confused some ECB observers because it clashed with the bank’s insistence that it would make decisions “meeting-by-meeting” and data-driven.
“There is an internal contradiction here that words cannot resolve,” said Francesco Papadia, a former senior ECB official who is now a staffer at the Bruegel think tank.
The ECB’s new projections on Thursday justified Ms Lagarde’s promise of more rate hikes and showed inflation to be above the ECB’s 2% target through 2025.
And Ms Lagarde said inflation could be even higher, citing the possibility of stronger-than-expected wage growth and a boost in demand from government support measures across the 19 eurozone countries.
However, those forecasts have been slammed as “euphemistically controversial” by none other than former ECB Vice President Vitor Constancio, who doubted inflation could stay at 3.4% in 2024 even if prices, including oil, fell.
“But the problem is that these December forecasts, given by the national central banks (Bundesbank etc.), contain a lot of non-model ‘judgment’,” the Portuguese economist said on Twitter.
The ECB also said it currently expects a recession to be “relatively short-lived and superficial” and Lagarde noted that euro-area unemployment figures are “at rock bottom”.
The ECB also unveiled plans to stop replacing maturing bonds in its 5 trillion euros ($5.31 trillion) portfolio, reversing years of asset purchases that have made the central bank the largest creditor of many governments in the world made euro zone.
Under the plan, it will reduce monthly reinvestments from its asset purchase program by €15 billion from March and revise the pace of balance sheet shrinking from July.
The move, designed to drain liquidity from the financial system, is intended to raise long-term borrowing costs and follows a similar move by the Fed earlier this year.
The impact was felt immediately by the eurozone’s weakest borrowers, such as the Italian government, who have come to rely on the ECB as their main buyer.
The yield on 10-year Italian bonds rose 31 basis points to 4.19%, the biggest one-day change since the pandemic-induced market crisis in March 2020.
“The shrinking of the ECB’s balance sheet combined with… higher fiscal spending needs amid the ongoing energy crisis could renew the upward pressure on euro area government bonds,” said Daniele Antonucci, chief economist at Quintet Private Bank.
The ECB said it would update the market by the end of 2023 on the “endpoint of balance sheet normalization” and by how much it plans to reduce liquidity in the banking sector.
This is crucial for determining the banks’ refinancing costs and thus the interest rates for companies and households. – Reuters