ECB shocked to find inflation continues here, up 75bps, after rising 50bps in July

Recklessly late, it has climbed much faster than forecasters even imagined a few months ago: 125 basis points in two meetings and promising more.

By Wolf Richter for WOLF STREET.

The ECB announced today that it will increase its three key interest rates by 75 basis points, taking its deposit rate from 0% to +0.75%, thus ending the era of interest rate policy. zero interest (ZIRP). This is the largest rate hike since 1998, at the very start of monetary union, when countries were still using their local currencies.

At its July meeting, the ECB ended its negative interest rate policy (NIRP) by raising its key rates by 50 basis points, its first rate hike since 2011 and the largest since June 2000. The rate hike pushed its deposit rate up from -0.5% to 0.0%. These two terms – ZIRP and NIRP – have become expressions of central bank induced financial absurdity.

And the ECB is shocked, shocked, that inflation is continuing here, and so there will be more rate hikes “over the next few meetings” because “inflation remains far too high and is likely to remain above target for an extended period”. period”, and the ECB must “rein in demand and guard against the risk of a persistent rise in inflation expectations”.

As of September 14, the ECB will increase its:

  • Deposit rate, currently 0.0%, to 0.75%. RIPZIRP.
  • Main refinancing rate, currently 0.5%, to 1.25%
  • Marginal lending rate, currently 0.75%, to 1.50%.

EQ is over.

The ECB confirmed today that QE is over. Its Asset Purchase Program (APP) and Pandemic Emergency Purchase Program (PEPP) will maintain their current balances and replace maturing securities with new ones.

Balances in its “Targeted Longer-Term Refinancing Operations” (TLTRO III) with banks fell as loans matured. The ECB said it “will continue to monitor bank funding conditions and ensure that as operations mature [under TLTRO III] “does not hinder the smooth transmission of its monetary policy”.

Recklessly late, but moving much faster than imagined a few months ago.

QE has finally come to an end. NIRP, the greatest nonsense of all, has finally come to an end. And now ZIRP has finally come to an end. But with headline inflation at 9.1% and a key rate at 0.75%, the ECB is still throwing a lot of fuel on the inflation fire, making it the most reckless of the major central banks.

But it’s moved much faster — rising 125 basis points in two meetings — than people predicted just a few months ago. At the time, forecasters saw one or two timid 25 basis point hikes this year, taking its deposit rate to perhaps 0% by the end of 2022. Turns out its deposit rate could well exceed 2% by the end of this year, which seemed like an incredibly high rate just a few months ago.

Inflation started to soar in March 2021 and has exploded this year.

Inflation in the Eurozone, similar to inflation in the United States, started to rise in early 2021, almost a year before the war in Ukraine. In July 2021, it exceeded the ECB’s target. In February 2022, it reached 5.9%. And then it went from there to 9.1% in six months, a record high in eurozone data dating back to 1997.

For most of this period, the ECB vigorously brushed off inflation. It’s been a bit over the past few months that he’s gradually started to take inflation seriously.

What is happening in the Eurozone right now is runaway inflation, with CPI hitting 25.2% in Estonia and nine out of 19 Eurozone countries experiencing double-digit inflation. It’s a horror show, despite the fact that national governments spend several billion euros on all sorts of subsidies and tax exemptions that drive down retail energy prices, transport prices and other elements.

The ECB recognizes that inflation is spreading, including in services.

Inflation is a big theme in the ECB statement. “Price pressures have continued to build and spread across the economy and inflation could rise further in the near term,” he said.

The ECB has “significantly revised upwards” its inflation projections, despite the tightening of monetary policies and the “substantial slowdown” in economic growth:

  • 2022: 8.1%
  • 2023: 5.5%
  • 2024: 2.3%

Energy prices which started to soar in Europe at the start of 2021 and this year have exploded.

Inflation less energy, food, alcohol and tobacco products rose from 2.3% in January to 4.3% in August. And services inflation rose from 2.3% in January to 3.8% in August.

Energy prices will eventually drop by at least some amount, but inflation in services, which is a large part of the economy, is particularly difficult to control.

“Energy remains, of course, the main source of inflation,” ECB President Christine Lagarde said at the press conference, “but we also have inflation spreading to a wider range of sectors”.

Glue gun in hand.

“The transmission protection instrument is available to counter unwarranted and disorderly market dynamics which pose a serious threat to the transmission of monetary policy in all euro area countries, thereby enabling the Governing Council to fulfill more effectively fulfill its price stability mandate,” the ECB said. in the statement.

This TPI is the glue gun for maintaining the cohesion of the euro zone. Its aim is to allow the ECB to raise rates and tighten them, while preventing the spread between, for example, German and Italian government yields, from exploding and triggering a new sovereign debt crisis.

As part of this program, the ECB can target the bonds it allows to leave the balance sheet and the bonds it buys, based on the yields of the fiscally weakest countries. For example, if the spread between German and Italian yields starts to explode, he can let maturing German bonds roll off his balance sheet while buying a similar amount of Italian bonds.

The hope is that the mere existence of the tool will keep the markets online so that the ECB won’t even need to use the tool that much.

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