The European Central Bank will enter a new era on Thursday. Policy makers will see how soon the bond purchase program will end and reaffirm their plans to raise interest rates in the summer for the first time in more than a decade.
Inflation has exceeded economists’ expectations across the euro area. In May, inflation rose to 8.1%, the highest since the creation of the euro currency in 1999. Policy makers are accelerating faster action against inspiring inflation. By the war in Ukraine.
The central bank will also provide up-to-date economic forecasts on Thursday. This can portray a tough situation with rising inflation and worsening growth prospects. Last month, the European Commission said it would lower its economic growth forecast for this year from 4% in winter to 2.7%, with an average annual inflation rate of 6.8%.
But the need to tackle inflation outweighs concerns about a slowdown.
For most of the last decade, policy makers have been fighting inflation that is too low. However, as consumer prices rose in late 2021 and began to spread to more commodities and services, banks stepped up the so-called policy normalization process, including the possibility of raising negative interest rates. Inflation forecasts for 2024 are an important sign of whether medium-term inflation is expected to exceed the bank’s 2% target, further strengthening conditions for monetary tightening.
In late May, bank president Christine Lagarde showed in unusually clear terms the expected path to rising interest rates and showed signs of rising in July and September. “Given the current outlook, we’re likely in a position to eliminate negative interest rates by the end of the third quarter,” Lagarde wrote in a blog post. Banks’ more hawkish tone has also helped lift the euro from its five-year low against the dollar in the past few weeks. Lagarde will lead a press conference in Amsterdam on Thursday afternoon.
At the moment, the central bank’s deposit rate that banks receive to deposit overnight with the central bank is minus 0.5%, effectively encouraging banks to lend money to the central bank rather than deposit it. It’s a penalty. .. Interest rates first fell below zero in mid-2014 as inflation fell towards zero.
Traders are listening carefully for clues about the magnitude of potential rate hikes. Financial markets are currently betting on deposit rates rising by 130 basis points, or 1.3 percentage points or more, by the end of the year.
Central bank chief economists recently said the increase is likely to be a quarter percentage point at a time, but some policy makers have justified a larger than normal 0.5 percentage point increase. Suggested that it might be.
Analysts at Bank of America expect the central bank to raise interest rates by 1.5 percentage points this year. “The pressure to move faster (and slower) will continue to grow from here,” they wrote in a note to their clients.
As a precursor to interest rate hikes, policymakers suggest that banks’ bond purchase programs are a way to keep borrowing costs down and inject money into the system, ending in early July. (The special pandemic bond buying program ended in March after buying € 1.7 trillion.) This month, banks will buy € 20 billion primarily in government bonds. The program started in 2015 and its purchases expanded and contracted as policymakers sought to heat and cool the economy as needed. As of May, the program held more than € 3 trillion in bonds.
But even if banks stop expanding their asset purchase programs, authorities will carefully monitor the cost of borrowing in debt-bearing countries as interest rates rise. The purpose is to ensure that their debt yields do not deviate significantly from other countries such as Germany. This year, Spain’s 10-year Treasury yield and Germany’s spread widened from 70 basis points to 113 basis points.
Reinvesting returns from maturity bonds can be used to avoid this so-called fragmentation. Central banks have already emphasized the flexibility of their asset purchase programs, but investors are watching to see if banks provide details on how to handle diverse borrowing costs.
