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European Central Bank surprises markets with larger-than-expected rate hike, its first in 11 years

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The European Central Bank is increasing interest rates for the first time in 11 years. But in Italy, political turmoil is back.
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The European Central Bank on Thursday increased interest rates for the first time in 11 years in an attempt to cool rampant inflation in the euro zone.

The ECB, the central bank of the 19 nations that share the euro currency, pushed benchmark rates up by 50 basis points, bringing its deposit rate to 0%. The Frankfurt institution had kept rates at historic lows, in negative territory since 2014, as it dealt with the region’s sovereign debt crisis and the coronavirus pandemic.

“The Governing Council judged that it is appropriate to take a larger first step on its policy rate normalisation path than signalled at its previous meeting,” the ECB said in a statement.

The ECB had previously signaled it would be increasing rates in July and September as consumer prices keep surging. A first reading for inflation in June showed a record high of 8.6%. However, some investors are skeptical over the ECB’s actions as they predict a recession later this year.

Back in June, ECB forecasts pointed to an inflation rate of 6.8% for the whole of this year, and 3.5% in 2023. In terms of growth, the central bank estimates a GDP rate of 2.1% for this year and the next.

One of the biggest uncertainties going forward is whether Russia will cut supplies of natural gas to Europe completely. Moscow has been accused of weaponizing fossil fuels as the EU slaps tough sanctions on the Kremlin for its unprovoked onslaught in Ukraine.

Natural gas flows have fallen by about 60% since June and a critical pipeline, Nord Stream 1, saw supplies resume Thursday after maintenance — albeit at a reduced capacity.

Europe’s Economics Commissioner Paolo Gentiloni has said that a full cut-off in supplies from Moscow, with Europe so dependent on Russia hydrocarbons, could push the euro zone into a recession this year, though this isn’t the EU’s base-case scenario currently.

Anti-fragmentation tool

Meanwhile on Thursday, investors kept a keen eye on details regarding the ECB’s new anti-fragmentation tool, which is aimed at supporting those nations with lofty debt piles, like Italy.

Expectations point to some conditionality between implementing strict domestic reforms and qualifying for this new instrument. This becomes particularly important in the context of Italian politics, where snap elections are now expected to take place in the fall after Prime Minister Mario Draghi resigned Thursday morning.

A credible government that sticks to the targets agreed with the European Commission will be critical if it’s to benefit from the new tool.

Yields on the Italian 10-year bond rose sharply to 3.6520% Thursday morning on news of Draghi quitting. Stock markets moved lower with Italy’s main index down by 1.4% in late morning European trade.

This is a breaking news story and it is being updated.

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