Momentum is building for the European Central Bank (ECB) to raise interest rates in July to fight soaring inflation, after dovish policymakers indicated they are ready to accept an end to almost eight years of negative borrowing costs.
ECB chief economist Philip Lane and executive board member Fabio Panetta have signalled they are now more open to raising rates in the coming months, following calls from the governing council's hawks to make the first rise in more than a decade sooner rather than later.
Costs
The hawkish shift comes after euro zone inflation hit a record 7.5 per cent in April and brings the ECB closer in line with the Federal Reserve and the Bank of England, which both raised rates this week. However, the euro zone’s monetary policymakers still lag far behind their peers in the US and UK in the cycle of raising interest rates.
The ECB has set borrowing costs below zero since June 2014, when it was still fighting Europe’s debt crisis. The deposit rate is now minus 0.5 per cent.
On Friday the additional borrowing costs investors demand to hold Italian debt over that of Germany climbed above 2 percentage points for the first time since 2020, underscoring concerns that any ECB tightening of monetary policy will mainly effect riskier euro zone countries.
The so-called “spread” between the two bond yields is a closely watched barometer of investor concerns about political and economic risks in the euro area.
For many years, hawks have been greatly outnumbered by doves among rate-setters, but soaring inflation has changed the balance of power in recent months.
Policymakers such as vice-president Luis de Guindos and executive board member Isabel Schnabel have said a series of rate rises could start by July. Many economists expect a 0.25 percentage point rise in the deposit rate to minus 0.25 per cent at the July meeting.
Lane, seen as one of the rate-setting governing council’s more dovish members, said on Thursday: “It is clear that at some point we are going to be moving rates not just once, but over time in a sequence.” Asked if this could happen in July, he told an event at think-tank Bruegel that the timing of the ECB’s first rate rise “should not be seen as the most important issue”.
“Once we do start moving . . . then the whole conversation will be: ‘OK, how much are you going to do and how quickly’,” he said, adding that “normalisation” would mean rates rising above zero, providing inflation remained on track to hit the central bank’s 2 per cent target.
Policy
The comments mark a further shift by Mr Lane, who in February was still predicting most inflation would “fade away” within 12 to 18 months, playing down the urgency to shift policy.
Mr Panetta, the most dovish member of the ECB board, has continued to push back against the idea of raising rates at its meeting on July 21, telling La Stampa on Thursday that it should wait to see what second-quarter growth data showed later that month.
However, he also said that given the rise in inflation expectations, the ECB could “gradually reduce the level of monetary accommodation.”
He added: “Under current circumstances, negative rates and net asset purchases may no longer be necessary.”
“This is probably the moment when doves cry and capitulate under too much pressure from the hawks,” said Carsten Brzeski, head of macro research at ING. “It’s fair to state that both Panetta’s and Lane’s attempts to prevent a rate hike in July were halfhearted, to say the least.”
More centrist members of the ECB’s governing council, which includes eurozone national central bank chiefs as well as executive board members, have also shifted to supporting a July rate rise.
Banque de France governor François Villeroy de Galhau said in a speech on Friday that he “wouldn’t preclude” a rate rise in the next few governing council meetings, adding: “Barring unforeseen new shocks, I would think it reasonable [for policy rates] to have entered positive territory by the end of this year.”
Prices
Mr Villeroy said the ECB needed to “carefully watch exchange rate developments” after the euro fell to a five-year low of $1.05 against the dollar, fuelling inflation by driving up import prices. “A euro that is too weak would go against our price stability objective,” he said.
Katharina Utermöhl, an economist at Allianz, said: "Recent communication by several top officials suggests that the ECB in early May has pretty much already made up its mind regarding raising interest rates as soon as July."
Finland's central bank boss Olli Rehn said on Thursday: "I think it would be justified to increase the deposit rate by 0.25 percentage points in July and to zero when autumn comes." The ECB should press ahead with tightening policy despite the risk of eurozone recession next year, Rehn added.
“There is no need to delay the normalisation of monetary policy,” Rehn told Helsingin Sanomat.
Austria’s hawkish central bank chief Robert Holzmann on Thursday said the bank would “probably” raise rates at the June policy meeting.
Russia’s invasion of Ukraine and China’s coronavirus lockdowns have raised fears that Europe’s economy could suffer an economic downturn this year.
Some economists fear the ECB could tighten policy on the cusp of a recession. The last time the central bank raised rates in 2011 was just as the region's debt crisis started. "Everything reminds me so much of 2011," said Silvia Ardagna at Barclays.
In early European trading on Friday, the gap between Italian and German bond yields reached the highest level since the depths of the coronavirus crisis in May 2020.
Italy, which has a government debt load of more than 150 per cent of gross domestic product, has been a big beneficiary of the ECB’s bond-buying programmes and historically low interest rates. – Copyright The Financial Times Limited 2022
