ECB signals first interest rate hike in a decade

The European Central Bank (ECB) will be raising key interest rates by 25 basis points at its July monetary policy meeting, marking the first interest rate hike in over a decade. 

The ECB said it also expects to raise rates in September by a "larger increment" if the current inflation outlook does not improve. Beyond September, it anticipates that "a gradual but sustained path of further increases in interest rates will be appropriate".

"In the meantime, the Governing Council decided to leave the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility unchanged at 0.00%, 0.25% and -0.50% respectively," the ECB said after the governing council met in Amsterdam. 

The central bank will also be halting its bond buying programme early next month while continuing to reinvest until at least the end of 2024. 

"The European Central Bank (ECB) is in a challenging position, with inflation extremely high, growth slowing and the labour market tightening. We now see euro area recession risk as high as 60 per cent for the second half of 2023," said Hetal Mehta, senior European economist at LGIM.

"As a result, unusual steps have been taken to clarify the short term interest rate path, but the pressure is on from more hawkish members to move at a faster pace." 

The ECB also published its new staff projections for growth and inflation. Inflation projections were revised up to 6.8% in 2022 and 3.5% in 2023, while the key medium-term inflation projection showed inflation above target at 2.1% in 2024.

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Fidelity's global macroeconomist Anna Stupnytska said "too much too soon could be a riskier strategy" for the ECB in light of a "weakening growth backdrop as well as the risk of peripheral spread fragmentation".

"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," she said. 

"While a new spread management tool might help prevent spread fragmentation, it will not be a silver bullet as will likely bring a new set of issues for the ECB, including moral hazard."