THE ECB RAISES INTEREST RATES BY 0,25 POINTS IN JULY TO FIGHT INFLATION

Between the risks of out-of-control inflation due to the war and energy prices, and the risks of recession caused by skyrocketing prices, the ECB has decided to focus on the former, following in the footsteps of the American Federal Reserve. An inflation's slowdown to 6,8% in Eurozone from the 8.3% peak is expected, which, if denied, would make a 'soft landing' to avoid recession more difficult. The new estimates of the ECB foresee this, which defines inflation as "a big challenge". The new statistics have been "revised significantly downward" for growth, for 2022, to 2.8%, and for 2023, to 2.1% while for 2024 there is a slight improvement to 2.1%.

Moreover, the ECB has decided that "interest rates on main refinancing operations, marginal lending facility, and central bank deposits will remain unchanged at 0.00%, 0.25% and -0.50% respectively". Over a longer period, the Governing Council" expects a further rise in key rates in September.

The decade of quasi-deflation, which required remunerating those who borrowed with negative rates, is over, "we are in a different universe," Lagarde said. 'We will make sure that inflation (8.1 % in May) returns to the target' of 2%. To get there, the ECB first decided to end the era of 'quantitative easing'. It will stop net bond purchases as of 1 July. This is a momentous change for the countries with the most debt, which in 2020 and 2021 had seen their entire needs financed by Frankfurt.

Inevitable are the repercussions on the spread. The ECB's 'plan A', to intervene in the event the alert level is reached, is to use flexibly (and perhaps finance 'green' projects) the reinvestments of the bonds bought with the 'Pepp' pandemic programme that come due. If this is not enough 'we are ready to deploy an adjustment of existing instruments or new instruments', 'we will not tolerate' financial fragmentation, Lagarde assures.

For the time being, 'plan B' is a verbal commitment, accompanied by the clarification that "there is no specific level of bond rates or loans, or bond spreads that will trigger this or that intervention". A sign that there are divisions in the ECB Council and that it is better not to tie hands.

In September, when there will be an encore and "a larger increase will be appropriate" if medium-term inflation estimates do not fall from forecasts that today give 6.8% in 2022, 3.5% in 2023, and 2.1% in 2024. Without excluding an 'energy shock' scenario that would bring prices to 8% in 2022 and 6.4% in 2023, before slowing to 1.9% in 2024.

After September, a 'gradual but sustained pace of further increases' is to be expected for rates. For the ECB, with Europe so exposed to the impact of war, it is a razor's edge balance. The risks come from the impacts of a possible escalation of Putin's war and from possible further energy shocks: in the ECB's most negative scenario, growth in 2022 from the already drastically reduced base assumption of 2.8% would be more than halved to 1.3%, and would become negative in 2023 (-1.7%).

Decision of European Central Bank - ECB