Breaking: ECB leaves rates unchanged at -0.50% as expected, signals end to QE and 25 bps hike in July

On Thursday, the European Central Bank's (ECB) governing council decided to keep its benchmark deposit rate at -0.50%, as unanimously expected by market participants. The bank also said that it intends to raise interest rates by 25 bps at the July meeting, after having ended its Asset Purchase Programme (APP) on 1 July. The ECB added that a larger than 50 bps rate hike might be appropriate at the September meeting. 

Key Additional Takeaways: 

Economic Commentary...

The ECB said that in May, inflation rose significantly due to surging food and energy prices, partly due to the impact of the Russo-Ukraine war. Inflation pressures have broadened and intensified, the bank noted.  

Eurosystem staff have revised their baseline inflation projections up significantly and these projections indicate that inflation will remain undesirably elevated for some time. 

However, moderating energy costs, an easing of supply disruptions related to the pandemic and the normalisation of monetary policy are expected to lead to a decline in inflation. 

New staff projections foresee annual inflation at 6.8% in 2022, before it is projected to decline to 3.5% in 2023 and 2.1% in 2024, much higher than the projections in March.

This means that headline inflation at end of the projection horizon is projected to be slightly above ECB’s target. 

Inflation excluding energy and food is projected to average 3.3% in 2022, 2.8% in 2023 and 2.3% in 2024, also above the March projections. 

Russia’s unjustified aggression towards Ukraine continues to weigh on the economy in Europe and beyond. 

It is disrupting trade, is leading to shortages of materials, and is contributing to high energy and commodity prices. 

These factors will continue to weigh on confidence and dampen growth, especially in the near term. 

However, conditions are in place for the economy to continue to grow on account of ongoing reopening, a strong labour market, fiscal support and savings built up during the pandemic. 

Once current headwinds abate, economic activity is expected to pick up again. 

This outlook is broadly reflected in the Eurosystem staff projections, which foresee annual real GDP growth at 2.8% in 2022, 2.1% in 2023 and 2.1% in 2024. 

Compared with the March projections, the outlook has been revised down significantly for 2022 and 2023, while for 2024 it has been revised up. 

Commentary on rate hikes...

The ECB reaffirmed its commitment to bringing Eurozone inflation back to 2.0% and referred to inflation as a challenge for us all. 

On basis of its updated assessment, the ECB decided to take further steps in normalising its monetary policy. 

If the medium-term inflation outlook persists or deteriorates, a larger rate hike will be appropriate at the September meeting. 

In line with the ECB’s commitment to its 2% medium-term target, the pace at which the ECB adjusts its monetary policy will depend on incoming data and how it assesses inflation to develop in the medium term. 

Beyond September, based on its current assessment, the ECB anticipates that a gradual but sustained path of further increases in interest rates will be appropriate.

Throughout this process, the ECB will maintain optionality, data-dependence, gradualism and flexibility in the conduct of monetary policy.

Commentary on QE reinvestments...  

The ECB intends to continue reinvesting, in full, principal payments from maturing securities purchased under APP for an extended period of time past the date when it starts raising interest rates and, in any case, for as long as necessary to maintain ample liquidity conditions and an appropriate monetary policy stance. 

As concerns Pandemic Emergency Purchase Programme (PEPP), the ECB intends to reinvest 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. 

In the event of renewed market fragmentation related to the pandemic, PEPP reinvestments can be adjusted flexibly across time, asset classes and jurisdictions at any time. 

This could include purchasing bonds issued by the Hellenic Republic over and above rollovers of redemptions in order to avoid an interruption of purchases in that jurisdiction, which could impair the transmission of monetary policy to the Greek economy while it is still recovering from fallout from the pandemic. 

Net purchases under the PEPP could also be resumed, if necessary, to counter negative shocks related to the pandemic. 

Refinancing operations at the ECB will continue to monitor bank funding conditions and ensure that maturing of operations under the third series of TLTRO (TLTRO III) does not hamper the smooth transmission of its monetary policy.