The European Central Bank (ECB) raised three official interest rates by another 0.25%, setting the deposit rate at 3.25%, the refinancing rate at 3.75% and the marginal credit rate at 4%. This is the first in a series of increases of less than half a percentage point, which would indicate that the ECB is nearing the end of monetary policy tightening.
However, President Christine Lagarde was at pains to emphasize at the press conference that “we (the ECB) are not giving up,” and that, based on her March projections, “…we believe we have more to go.” “. Although “it depends on the data”, it is clear that the Governing Council is still not satisfied with the progress made in reducing inflation.
Lagarde also mentioned that previous interest rate hikes “… had a strong impact,” and that the central bank’s recent Bank Lending Survey suggests that interest rates are in limited territory. Banks reported a decrease in loan production, due to the increase in interest rates but also a decrease in economic demand.
The labor market remains stable, as the latest estimate of the unemployment rate for March shows another drop of 6.5%. This is considered one of the upside risks of inflation. If employment growth remains stronger than expected, demand and inflationary pressures may persist.
Concerns were also raised about the stability of the banking sector, with mentions of Silicon Valley Bank and Credit Suisse. While Lagarde views rising tensions as a downside risk, there is no immediate danger of action.
In addition to the rate hike, the ECB also announced that starting July it will end the reinvestment of its assets under the Asset Purchase Program (APP). This move is expected to reduce the ECB’s balance sheet by an average of 25 billion euros per month, but will take 15 years to fully close. Meanwhile, the Pandemic Emergency Purchase Program (PEPP) will continue to be reduced at a rate of €15 billion per month until next month. We hope to have an announcement in due course which will facilitate PEPP settlement from July.
We also expect the ECB to raise rates by another 0.25% in June, but the likelihood of further hikes after this is lower. If inflation remains steady, a further rate hike could happen in July. This takes monetary policy into very tight territory, maybe even too tight, with a margin of error.
