The European Central Bank announced its third consecutive interest rate hike this year.
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The European Central Bank on Thursday announced a 75 basis point hike in interest rates – its third consecutive increase this year – while reducing support for European banks.
Following much speculation from market participants, the ECB said it is now changing the terms and conditions of its Targeted Longer-Term Refinancing Operations, or TLTROs. It is a tool that offers European banks attractive borrowing conditions, designed to incentivize lending to the real economy.
However, since the ECB has raised rates faster than expected in the face of soaring inflation, European lenders are benefiting from both the TLTROs and the rise in interest rates. The situation was described as effectively providing a subsidy to the banks.
“During the acute phase of the pandemic, this instrument has played a key role in addressing downside risks to price stability. Today, given the unexpected and extraordinary rise in inflation, it must be recalibrated,” the ECB said in a statement.
Therefore, he added that the interest rates applicable to the tool, known as TLTRO III, would be adjusted from November 23 to match the deposit facility rate, which is the main benchmark for the ECB. In addition, banks will also be offered voluntary prepayment dates.
“In order to bring the remuneration of the minimum reserves held by credit institutions with the Eurosystem more closely into line with money market conditions, the Governing Council has decided to set the remuneration of the minimum reserves at the deposit facility rate of the ECB.”
This will lead to a significant increase in the cost of loans for banks under the program.
ECB President Christine Lagarde told reporters that the November 23 date would allow banks to adjust to the new conditions.
Too early to cut the balance sheet
Market participants had also asked if the central bank would provide details on when it would begin to reduce its balance sheet by 8.8 trillion euros ($8.8 trillion), in a process known as quantitative tightening.
Lagarde said the conditions for taking that step will be discussed in December, but added that her team will look at three main factors: the inflation outlook, the measures taken so far and the transmission lag – given that this takes some time. that the monetary decision has an impact on the economy.
The euro weakened against the US dollar in the wake of ECB announcements. The common currency briefly fell below parity before recovering slightly.
Yields on European government bonds also fell following the ECB’s decision.
More rate hikes to come
Thursday’s rate hike takes the ECB’s main benchmark from 0.75% to 1.5%, a level not seen since 2009 before the sovereign debt crisis. This comes after the central bank raised rates by 50 basis points in July and 75 basis points in September.
However, the ECB has confirmed that its rating upgrade cycle is not over yet.
“With this third consecutive major policy rate hike, the Governing Council has made substantial progress in withdrawing monetary policy easing. The Governing Council has taken today’s decision and expects to raise further interest rates, to ensure inflation quickly returns to its 2% medium-term inflation target,” the central bank said.
Several economists have forecast another rate hike in December of 50 basis points. The ECB, however, did not indicate the level of future rate hikes, saying they will depend on the data.
Speaking at a press conference, Lagarde said the bank had made “substantial progress” in reducing its dovish stance, which had been in place since the debt crisis and continued during the period. pandemic.
However, she added that this so-called “normalization” process is not over. “We’re not done yet, there’s still a long way to go,” she said.
It comes as the ECB faces record inflation and a slowing economy, with many economists predicting a recession in the region before the end of the year. It’s a delicate balance for the central bank, because if it raises rates aggressively in an effort to fight inflation, it could cause even more problems for the wider economy.
“Inflation remains far too high and will remain above target for an extended period,” the ECB also said on Thursday.
In September, inflation in the 19-member bloc was 9.9%.
Lagarde also acknowledged that the likelihood of a recession has increased.
Asked about the impact of ECB decisions on growth, Lagarde said: “We have to do what we have to do.”