ECB Raises Rates Another 25bps, Hints May be End of Rate Hikes

ECB raised key rates by 25 bps in its July monetary policy decision to 4.25% as expected, the highest level, and the rate on the deposit facility to a 22-year high of 3.5%. The move follows a 25-bps rate hike last meeting in the ninth consecutive rate hike. This despite the Eurozone entered a recession at the beginning of 2023. The bank said inflation continues to decline but is still expected to remain too high for too long. Expectation is that inflation will drop further over the remainder of the year. Tere wasa subtle hint that this may have been the final hike in this cycle, the EUR sold off slightly

BankofECB

Policymakers expect to raise interest rates further, to ensure the timely return of 2% inflation target.

ECB Monetary Policy Decision July 27 2023

  • Main refinancing rate at 4.25% vs 4.00% prior expected 4.25%
  • Deposit facility rate 3.75% vs 3.75% expected Prior 3.50%
  • Marginal lending facility 4.50% Prior 4.25%

Highlights

  • Inflation continues to decline but is still expected to remain too high for too long
  • Expectation is that inflation will drop further over the remainder of the year
  • But it will stay above target for an extended period
  • ECB decides to set the remuneration of minimum reserves at 0%
  • This is to preserve the effectiveness of monetary policy transmission
  • ECB stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its 2% target over the medium term
  • To follow a data-dependent approach to determining the appropriate level of interest rates
Euro Area Interest Rate

There is a very slight change by the ECB and that is weighing on the euro. In June, they said that:

“The Governing Council’s future decisions will ensure that the key ECB interest rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary.”

In July, now they are saying that:

“The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary to achieve a timely return of inflation to the 2% medium-term target.”

That’s indicative that they may perhaps be done with rate hikes already. EUR/USD is down from around 1.1125 to 1.1100 currently.

ECB Projections June

  • 2023 inflation at 5.4%
  • 2024 inflation at 3.0%
  • 2025 inflation at 2.2%
  • 2023 GDP at 0.9%
  • 2024 GDP at 1.5%
  • 2025 GDP at 1.6%

Labour cost pressures on inflation continue to intensify across the Eurozone and keeps the balance toward greater hawkishness from ECB:

Market Reaction

EURUSD fell as perhaps be done with rate hikes already. EUR/USD is down from around 1.1125 to 1.1100 currently.

NB LTRO (Targeted Longer-Term Refinancing Operations) is best described as a long term loan to banks to increase loan creation. The banks lend above a specified benchmark and borrow from the ECB at a negative rate. This will provide an incentive for the banks to lend and thus increase private spending in the economy. That’s the theory clearly has not been a great success so far.

Holger Zschaepitz @Schuldensuehner
Holger Zschaepitz @Schuldensuehner

Full Statement by the ECB 15 June 2023

Inflation has been coming down but is projected to remain too high for too long. The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner. It therefore today decided to raise the three key ECB interest rates by 25 basis points.

The rate increase today reflects the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission. According to the June macroeconomic projections, Eurosystem staff expect headline inflation to average 5.4% in 2023, 3.0% in 2024 and 2.2% in 2025. Indicators of underlying price pressures remain strong, although some show tentative signs of softening. Staff have revised up their projections for inflation excluding energy and food, especially for this year and next year, owing to past upward surprises and the implications of the robust labour market for the speed of disinflation. They now see it reaching 5.1% in 2023, before it declines to 3.0% in 2024 and 2.3% in 2025. Staff have slightly lowered their economic growth projections for this year and next year. They now expect the economy to grow by 0.9% in 2023, 1.5% in 2024 and 1.6% in 2025.

At the same time, the Governing Council’s past rate increases are being transmitted forcefully to financing conditions and are gradually having an impact across the economy. Borrowing costs have increased steeply and growth in loans is slowing. Tighter financing conditions are a key reason why inflation is projected to decline further towards target, as they are expected to increasingly dampen demand.

The Governing Council’s future decisions will ensure that the key ECB interest rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary. The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, its interest rate decisions will continue to be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.

The Governing Council confirms that it will discontinue the reinvestments under the asset purchase programme as of July 2023.

Key ECB interest rates
The Governing Council decided to raise the three key ECB interest rates by 25 basis points. Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 4.00%, 4.25% and 3.50% respectively, with effect from 21 June 2023.

Asset purchase programme (APP) and pandemic emergency purchase programme (PEPP)
The APP portfolio is declining at a measured and predictable pace, as the Eurosystem does not reinvest all of the principal payments from maturing securities. The decline will amount to €15 billion per month on average until the end of June 2023. The Governing Council will discontinue the reinvestments under the APP as of July 2023.

As concerns the PEPP, the Governing Council intends to reinvest the principal payments from maturing securities purchased under the programme until at least the end of 2024. In any case, the future roll-off of the PEPP portfolio will be managed to avoid interference with the appropriate monetary policy stance.

The Governing Council will continue applying flexibility in reinvesting redemptions coming due in the PEPP portfolio, with a view to countering risks to the monetary policy transmission mechanism related to the pandemic.

Refinancing operations
As banks are repaying the amounts borrowed under the targeted longer-term refinancing operations, the Governing Council will regularly assess how targeted lending operations and their ongoing repayment are contributing to its monetary policy stance.


The Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation returns to its 2% target over the medium term and to preserve the smooth functioning of monetary policy transmission. Moreover, the Transmission Protection Instrument is available to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across all euro area countries, thus allowing the Governing Council to more effectively deliver on its price stability mandate.

The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 14:45 CET today.

Alternate player (audio: en,fr,de) Watch on Twitter @ECB

Live. https://www.ecb.europa.eu/home/html/index.en.html

Source: European Central Bank

From The TradersCommunity Research Desk