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ECB Policy Makers are Inclining to Increase interest Rates above Zero.

In: Finance, Forex

European Central Bank policy makers are increasingly embracing a scenario of taking interest rates above zero before the end of the year.

With Governing Council members already converging around a hike of a quarter point in July, at least two further moves of that size before January are becoming a plausible outcome for officials from across the decision-making spectrum.

That would suggest ECB policy makers are starting to align with the views of money markets, which currently show investors betting on three increases in the deposit rate from the current –0.5% before the year is out.

Money markets brought forward bets for ECB rate hikes, pricing around 91 basis points of tightening by year-end compared to 89 basis points before the report. The euro extended gains to trade around $1.0576.

Last week, calling the prospect of above-zero rates this year “reasonable,” Bank of France Governor Francois Villeroy de Galhau agreed publicly with that outlook. His Belgian colleague, Pierre Wunsch, said that such a scenario “would be a no brainer,” in an interview last month.

With inflation approaching four times the 2% target, officials including ECB President Christine Lagarde are now signaling readiness to enact the first rate increase since 2011 in July, speaking on Wednesday, she also stressed subsequent moves won’t be aggressive. Following the conclusion of net asset purchases shortly before then.

Lagarde said in a speech in Ljubljana, Slovenia: “After the first rate hike, the normalization process will be gradual.”

That would continue to set the ECB apart from the likes of the Federal Reserve and the Bank of England, which are acting more forcefully to combat the steepest inflation in decades. The US central bank delivered a half-point rate increase earlier this month.

Policy makers will likely keep a close eye on incoming data and market reactions to ensure their normalization steps don’t hurt the region’s economic recovery. Bank of America economists reckon ECB policy makers will probably be able to make four moves in 2022, bringing the deposit rate to 0.5% by December.

Price growth in the 19-member euro zone has broken record after record in recent months — driven partly by Russia’s war in Ukraine but also pandemic-related supply snarls. Fears over economic growth are also mounting, however, with German Finance Minister Christian Lindner warning Wednesday of the risk of stagflation.

The ECB first took rates negative in 2014, and they have remained below zero since then. That’s been a challenge for some countries, particularly Germany, where poor returns offered to savers by banks implementing the policy sparked criticism of the Frankfurt-based central bank.

Bundesbank President Joachim Nagel signaled against such a backdrop, how he is focused on exiting a negative stance as he too backed a first rate hike in July.

“When you’re in a territory below zero, it seems to be first of all necessary to get into positive territory back again and changing the focus away” from the ECB’s deposit rate and back to its so-called “main refinancing operations rate,” he said. “This is what I would like to achieve if we’re talking about the next steps.”

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