Christine Lagarde signalled that she would support raising the European Central Bank’s main interest rate in July, leading economists to declare that the first increase for more than a decade is almost certain to go ahead.
The ECB president said in a speech in Slovenia on Wednesday that she expected the bank to stop expanding its balance sheet through bond purchases “early in the third quarter” and to then raise rates “some time” after that, which “could mean a period of only a few weeks”.
Lagarde added that “actions that demonstrate our commitment to price stability” would be critical in ensuring businesses’ and households’ expectations of future inflation did not rise further and test the central bank’s credibility. Eurozone inflation hit a record 7.5 per cent in April — almost four times the central bank’s target of 2 per cent.
The remarks are a clear sign that Lagarde supports the growing number of governing council members that have called for a 25 basis-point rise in the ECB’s deposit rate at the July 21 policy meeting. The deposit rate is now minus 0.5 per cent and has been in negative territory since 2014, when it was lowered to help fight the region’s debt crisis.
Economists have been bringing forward their forecasts of when the central bank will raise rates. Reinhard Cluse at UBS on Wednesday predicted a 25bp increase in July would be the first of seven such moves to lift its deposit rate to 1.25 per cent by next year. Frederik Ducrozet, a strategist at Pictet Wealth Management, wrote on Twitter that a July rate rise by the ECB seemed “a done deal”.
ECB officials are increasingly concerned that the fallout from Russia’s invasion of Ukraine will keep inflation high for longer and embed expectations of rising prices among consumers and companies.
Lagarde said the war was “likely to accelerate two ongoing structural changes which, during the transition they entail, could lead to further negative supply shocks and cost pressures”.
The ECB’s new quarterly forecasts to be published in June were “increasingly pointing towards inflation being at least on target over the medium term”, she added. Luis de Guindos, vice-president of the ECB, predicted eurozone inflation would be as high as 5 per cent at the end of this year — higher than its forecast in March for inflation of 4 per cent in the fourth quarter of the year.
Several other ECB governing council members have spoken out in recent days to say they would support starting a series of rate rises in July and a majority on the 25-member rate-setting body seems to favour such a move.
Fabio Panetta, the most dovish member of the executive board, is the only one to argue against a July rate increase, preferring to wait until second-quarter growth figures are published a week later. Austria’s hawkish central bank governor Robert Holzmann even said it could raise rates in June, though he is seen as an outlier.
Frank Elderson, the newest member of the ECB’s executive board who joined in January, said earlier on Wednesday that it could consider raising rates in July, “dependent as always on the incoming data”. He added that a eurozone recession was not envisaged, providing the conflict in Ukraine did not escalate.
The hawkish shift brings the ECB closer in line with the US Federal Reserve and the Bank of England, which both raised rates recently. However, the eurozone’s monetary policymakers still lag far behind their peers in the US and UK in the cycle of raising interest rates and were the only ones of the trio to deploy negative rates as a policy tool.
Lagarde said the Ukraine war was “creating a challenge for monetary policy by tempering growth rates and pushing up inflation further”.
While “it looks increasingly unlikely the disinflationary dynamics of the past decade will return”, she said consumption and investment were still below pre-pandemic levels in the eurozone, meaning the ECB would aim to “normalise” rather than “tighten” monetary policy — signalling that it would only raise rates slowly to continue supporting activity.
“After the first rate hike, the normalisation process will be gradual,” she said, adding “flexibility will be key” — a reference to a possible “new instrument” the central bank has discussed to tackle any sudden surge of a country’s borrowing costs by buying its bonds.
The additional borrowing costs investors demand to hold Italian debt over that of Germany climbed higher than 2 percentage points last week for the first time in almost two years, underscoring concerns that any ECB tightening of monetary policy will mainly affect eurozone countries with higher debt burdens.
Some ECB officials have said there is little higher interest rates can do to tackle the supply constraints pushing up energy and food prices, but board member Isabel Schnabel said on Wednesday in Vienna that buoyant demand was as much to blame for high inflation.
Schnabel said a huge increase in household savings, which rose by $2.7tn in the US and €900bn in the eurozone during the pandemic, had allowed companies to increase their prices, adding it was “time to put an end to the measures that were activated to fight low inflation”.