ECB: Increase interest rates by 50 basis points

The European Central Bank announced its first interest rate hike in 11 years, opting for the most aggressive path of 50 basis points amid ever-increasing concerns about the impact of rising prices on households, companies and governments.

The long-awaited interest rate hike by the ECB now brings it closer to more than 80 central banks that have already raised theirs this year, although it is well behind the Federal Reserve, which began hikes in March and is gearing up for more a big increase of 75 basis points or maybe even 100.

In any case, the focus is more on the “anti-fragmentation” tool that will contain eurozone government bond spreads, the Transmission Protection Instrument (TPI) approved by the ECB’s Governing Council to “preserve the smooth transmission of direction of its monetary policy throughout the euro area”.

According to the ECB, the TPI will be an addition to the bank’s board’s toolbox and “can be activated to offset unwanted, disorderly market developments that pose a serious threat to the transmission of monetary policy in the euro area”.

The announcement also emphasizes that “the scale of purchases through the TPI depends on the severity of the risks posed to the transmission of policy,” while the ECB clarifies that “purchases are not limited in advance.”

The ECB announcement in detail:

“Today, in line with its strong commitment to its mandate of price stability, the Governing Council took further key steps to ensure that inflation returns to its 2% target over the medium term. The Governing Council decided to increase the three key ECB interest rates by 50 basis points and approved the instrument to protect the transmission (Transmission Protection Instrument – TPI).

The Governing Council considered it appropriate to take a larger first step in its policy rate normalization path than the indications it had given at its previous meeting. This decision is based on the Board’s updated assessment of inflation risks and enhanced support provided by the TPI for the effective transmission of monetary policy. It will support the return of inflation to the Governing Council’s medium-term objective by strengthening the stabilization of inflation expectations and ensuring that demand conditions adjust to meet its medium-term inflation objective.

During the upcoming meetings of the Board of Directors, further normalization of interest rates will be appropriate. Today’s acceleration of the exit from negative interest rates allows the Governing Council to move to an approach where interest rate decisions will be made on a meeting-by-meeting basis. The future path of the Board’s policy rates will continue to be evidence-based and will help meet its target of 2% inflation over the medium term. As part of its policy smoothing, the Board of Directors will evaluate various options for the interest on the excess liquidity held.

The Governing Council assessed that the establishment of the TPI is necessary in order to support the effective transmission of monetary policy. More specifically, as the Governing Council continues to smooth monetary policy, the TPI will ensure that the direction of monetary policy is smoothly transmitted to all euro area countries. The single character of the Governing Council’s monetary policy is a prerequisite for the ECB to be able to fulfill its mission of price stability.

The TPI will be an addition to the Governing Council’s toolbox and can be activated to hedge against unwanted, disorderly market developments that pose a serious threat to the transmission of monetary policy in the euro area. The scale of purchases through the TPI depends on the severity of the risks posed to the transmission of the policy. Purchases are not limited in advance. By preserving the transmission mechanism, the TPI will allow the Board to more effectively fulfill its mission of price stability.

In any case, the flexibility to reinvest amounts from the redemption of pandemic emergency purchase program (PEPP) portfolio securities as they mature remains the first line of defense against risks on the transmission mechanism related to the pandemic.

Key ECB interest rates

The Governing Council decided to increase the three key ECB interest rates by 50 basis points. Consequently, the interest rate on the main refinancing operations as well as the interest rates on the marginal financing facility and the deposit acceptance facility will be increased to 0.50%, 0.75% and 0.00% respectively, with effect from 27 July 2022.

During the upcoming meetings of the Board of Directors, further normalization of interest rates will be appropriate. Today’s acceleration of the exit from negative interest rates allows the Governing Council to move to an approach where interest rate decisions will be made on a meeting-by-meeting basis. The future path of the Board’s policy rates will continue to be evidence-based and will help meet its target of 2% inflation over the medium term.

Asset Purchase Program (APP) and Pandemic Emergency Asset Purchase Program (PEPP)

The Governing Council intends to continue to reinvest, in full, the proceeds of the redemption of securities acquired under the APP program at maturity for an extended period of time after the date on which it begins to raise key ECB interest rates and, at each case, for as long as it is deemed necessary to maintain conditions of abundant liquidity and the appropriate direction of monetary policy.

With regard to the PEPP scheme, the Board intends to reinvest the capital amounts from the redemption of securities acquired under the scheme at their maturity at least until the end of 2024. In any case, the future roll-down (roll- off) of the PEPP portfolio will be adjusted in such a way as to avoid interference with the appropriate direction of monetary policy.

Amounts from the redemption of PEPP portfolio securities are flexibly reinvested as they mature in order to address the risks to the transmission mechanism related to the pandemic.

Refinancing operations

The Governing Council will continue to monitor bank funding conditions and ensure that the expiry of operations under the third round of targeted longer-term refinancing operations (TLTROs III) does not impede the smooth transmission of its monetary policy. The Governing Council will also regularly assess how targeted financing operations contribute to the direction of its monetary policy.

The Governing Council stands ready to deploy all instruments at its disposal within the limits of its mandate to ensure that inflation stabilizes at the 2% target over the medium term. The new TPI approved by the Governing Council will safeguard the smooth transmission of its monetary policy direction across the euro area.”