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European Central Bank Raises Rates, To End QE – Reactions
10 June 2022
The is turning off the monetary taps, ending its bond-buying programme (known as quantitative easing) and raising rates by 25 basis points. This is the first time it has hiked rates for 11 years – a sign of how long the eurozone has subsisted on ultra-cheap borrowing since the 2008-09 financial crash. Matteo Cominetta, senior economist, Barings Investment Institute Silvia Merler, head of ESG and Policy Research, Algebris Investments Daniele Antonucci, chief economist and macro strategist, Quintet Private Bank
The ECB said it would raise its key interest rates by 0.25 per cent in July, with further increases planned for later in the year. QE will also halt on 1 July.
The US Federal Reserve and Bank of England have already pushed rates higher, and more are expected as central bankers wrestle with the highest inflation rates since the 1980s. A decade of QE, pandemic-related disruptions to supply chains, governments' decarbonisation policies, US tariffs on Chinese imports and the Russian invasion of Ukraine have arguably combined to cause the problem. The episode is also prompting debate on whether central bankers’ reliance in past decades on inflation targeting is wise.
Here are some reactions from economists and wealth managers:
One has to recognise that the ECB faces exceptionally unclear circumstances: the post-Covid reopening and a solid tourist season will push the recovery while extreme inflation, plunging confidence and potential worsening effects of war will all hinder it. Negative interest rates and QE are, however, hardly justifiable even with such elevated uncertainty, so it is probably the right choice to remove them.
That said, today’s decisions are putting a lot of weight on current conditions at the expenses of the medium term. This looks gloomy for Europe, with structural headwinds such as the historic energy shock, the need to redirect supply chains away from Russian imports and the green transition costs all piling up on an economy that did not show particular buoyancy in the last decade. As we move into 2023 and the temporary tailwinds dissipate, the full weight of the structural headwinds may become clearer and possibly force the ECB to cut rates, just as it did in 2011.
May’s inflation data surprised to the upside last week, paving the way for bolder action by the European Central Bank (ECB) over the summer. Eurozone-level data came in at 8.1 per cent for May, above the previous record of 7.4 per cent and the consensus expectations of 7.8 per cent.
Germany and Italy saw the most worrying inflation trends, against some sign of moderation in France and Spain. European data also shows early signs of rising wage pressures – the ECB’s negotiated wage indicators rose to 2.8 per cent for the first quarter of 2022, up from 1.6 per cent in the fourth quarter of 2021. Hawkish rhetoric from ECB speakers has picked up considerably over the past month, and May data meant that decently bold action had to follow. The fact that inflation hadn’t yet peaked made the June meeting this week a good opportunity to guide markets towards that.
Our outlook on euro area economic growth is more bearish than the ECB’s and we think the probability of recession over the next 12 months, while not our base case, is higher. This is due to the euro area’s high exposure to Russia/Ukraine and its impact on commodities and supply chains.
One downside risk, therefore, is that this policy tightening cycle, after the first few hikes, comes when the economy is weakening rapidly and, possibly, inflation may be turning from high levels. Another risk is the possible return of political risk premium and debt sustainability issues in Italy with, potentially, some contagion to other vulnerable members of the monetary union.
This is why we expect fewer hikes than priced by markets currently. Also, investors will be watching whether the ECB’s “anti-fragmentation” tools, including an adjustment to reinvestments and new pandemic purchases in case of yet another virus outbreak, are effective at containing these risks.
Seema Shah, chief strategist, Principal Global Investors
The ECB has never provided clearer forward guidance than they did today , signalling that a 0.50 per cent policy rate increase is likely unless inflation pressures subside. With energy prices, if anything, on an upward path and supply chain concerns unlikely to ease in the near future, inflation pressures will not be eroded quickly.
With this inflation outlook and the unavoidable path for higher rates, the ECB is facing stagflation threats full-frontal. The stranglehold of desperately high living costs means that the euro area growth will slow through the second half of this year, with recession increasingly likely – particularly now with sharp policy tightening in the near-term horizon.
The key beneficiary is the euro. The reversal in US and eurozone market interest rate expectations, with peak Fed expectations now likely behind us and ECB rate expectations rapidly moving higher, is challenging the strong dollar and a rally in the euro is in sight.
Anna Stupnytska, Fidelity
Continued upward surprises in European inflation and evidence of its persistence, as well as the Fed's “hostile” tightening path, are raising pressure on the ECB to frontload policy normalisation. While the risk of de-anchoring in longer-term inflation expectations does not seem high, rapid widening in policy differentials versus the Fed does present challenges for the ECB, with euro/dollar re-pricing in the spotlight. But doing too much too soon would arguably be a riskier strategy for the ECB in light of a weakening growth backdrop as well as the risk of peripheral spread fragmentation.
The headwinds related to the war in Ukraine, China's zero-Covid policy and tightening in global financial conditions will continue weighing on the eurozone’s growth, are likely to lead to a recession over the next few months. The timing and magnitude, however, largely depends on further developments in these three areas, as well as the fiscal policy response to the energy shock.
We believe it will be difficult for the ECB to execute a rapid return of policy rates into positive territory given the growth and fragmentation constraints and the tightening path will be less steep and shorter than what is currently implied by market pricing. While a new spread management tool might help prevent spread fragmentation, it will not be a silver bullet as it is likely to bring a new set of issues for the ECB, including moral hazard.
The is turning off the monetary taps, ending its bond-buying programme (known as quantitative easing) and raising rates by 25 basis points. This is the first time it has hiked rates for 11 years – a sign of how long the eurozone has subsisted on ultra-cheap borrowing since the 2008-09 financial crash.
Matteo Cominetta, senior economist, Barings Investment Institute
Silvia Merler, head of ESG and Policy Research, Algebris Investments
Daniele Antonucci, chief economist and macro strategist, Quintet Private Bank