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ECB Likely to Exit Negative Rates 

by Unlisted Blog   ·  May 23, 2022   ·  

ECB Likely to Exit Negative Rates 

by Unlisted Blog   ·  May 23, 2022   ·  

With inflation nearing the ECB’s 2 percent target, the Governing Council has been building momentum to raise the deposit rate from its current level of -0.5 percent in July. Lagarde’s comment suggests two 25-basis-point increases at the July and September policy meetings. 

While Dutch central bank chief Klaas Knot suggested last week that a half-point rate hike might be necessary, Lagarde has repeatedly stated that policy normalisation will be gradual, and she reiterated that sentiment on Monday.

According to President Christine Lagarde, the European Central Bank will likely begin raising interest rates in July and exit sub-zero territory by the end of September. 

“I expect net APP purchases to end very early in the third quarter,” she wrote in a blog post on Monday. “This would allow us to lift rates at our July meeting, in line with our forward guidance.” Based on current projections, we should be able to exit negative interest rates by the end of the third quarter.” 

“This means that it is prudent to proceed cautiously, keeping an eye on the effects on the economy and the inflation outlook as rates rise,” she explained. 

Following her remarks, the euro gained ground against the dollar, rising as much as 1% to 1.0674, its highest level in nearly a month. German 10-year bond yields fell 4 basis points to 0.98 percent, erasing earlier gains. 

“Lagarde has taken the unusual step of essentially announcing in advance a July interest rate increase and a September rate increase.” This clears up much of the uncertainty surrounding the ECB’s next moves and makes a 50 basis point hike in July seem unlikely.”

Russia’s invasion of Ukraine has pushed up commodity prices while increasing uncertainty about the outlook and eroding consumer and business confidence. This has created a difficult situation for policymakers, as any measures to control inflation risk slowing activity even further. 

Raising the deposit rate by 50 basis points through September would still leave the central bank trailing peers such as the Federal Reserve and the Bank of England, which have raised borrowing costs this year to combat rising inflation.

With her blog post, Lagarde stated that she wanted to “clarify the path of policy normalisation that lies ahead of us,” noting that the ECB needs to keep its options open due to uncertainty about future price growth. 

“Optionality is important to allow us to re-optimize the policy path as we go,” Lagarde said. “Key variables underpinning that path will only become clearer with time.” This could also imply withdrawing monetary stimulus “as soon as possible to eliminate the risk of a self-fulfilling spiral.”

The prospect of the first rate hike in more than a decade has heightened fears of bond market fragmentation among the currency bloc’s 19 members, as governments increased their debt loads to assist the economy in dealing with the Covid-19 pandemic. 

Lagarde stated again that the ECB will be able to “design and deploy new instruments” to ensure that monetary policy is properly transmitted throughout the eurozone.

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