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The European Central Bank raised interest rates by more than expected on Thursday, confirming that concerns about runaway inflation trump economic growth considerations for now.

The ECB raised its benchmark deposit rate by 50 basis points to 0%, breaking its own earlier guidance for a 25 bps move as it joined global peers in jacking up borrowing costs. It was the central bank’s first rate hike for 11 years.

Policymakers also unveiled their ‘anti-fragmentation’ tool called TPI that is designed to contain market stress in the bloc’s more indebted nations.

MARKET REACTION:

The euro initially jumped but then erased all gains and turned lower on the day during ECB President Christine Lagarde’s press conference that followed the rate decision. European stocks were volatile after the rate decision. Government bond yields climbed with 10-year German benchmark debt yields at their highest in three weeks.

COMMENTS

KURT KNOWLSON, SENIOR PORTFOLIO MANAGER, AVIVA INVESTORS:

“After 11 years, on a reassessment of the inflation outlook the ECB decided to front load its exit from negative rates, with a 50bp hike.

“The ECB are now moving to a more continuous forecasting regime for this cycle with rate movements being determined “meeting by meeting” which could increase the chance of more and larger rate hikes in the coming months.”

JULIEN LAFARGUE, CHIEF MARKET STRATEGIST, BARCLAYS PRIVATE BANK:

“The 50 basis points was partly expected. The market wasn’t fully pricing that simply because there was this uncertainty as to whether the situation in Italy would have an impact on the ECB’s thinking.

“The reason why the ECB went for a 50 basis point is one to try to restore credibility. And second its also a way to reassure the market that this new tool, the transmission protection instrument tool, is giving them sufficient confidence to go by 50 basis point.

“The main concern is here by going 50 and sending the message that they might slow down in the future - they have diminish the impact of forward guidance.”

JIM REID, HEAD OF GLOBAL FUNDAMENTAL CREDIT STRATEGY, DEUTSCHE BANK:

“Moving away from negative rates is a very big deal and its worth remembering that in H1 2021 rates were priced to stay negative for most of the rest of the decade so a lot has changed.

“Given the structural inflation forces were turning before covid, and continue to point in that direction after it, it’s possible we won’t see negative rates again in Europe as far as the eye can see.”

STUART COLE, HEAD MACRO ECONOMIST AT EQUITI CAPITAL:

“We now see the criteria that Lagarde has laid out for accessing TPI funds. If she is serious they look a very high bar for a country such as Italy to reach.”

ERIK NELSON, MACRO STRATEGIST, WELLS FARGO, NEW YORK:

“One of the biggest takeaways is that the ECB is more open-ended on their forward guidance. Previously, they suggested that they will do 50 in September and effectively 25 basis points per meeting thereafter. Now they are more open to do larger, smaller, potentially no hike or more hikes. I think what they want to do is offer themselves more flexibility and not pre-commit.

“The ECB’s impact on the euro will depend a lot on the transmission protection instrument...If this is a credible tool and it offers protection on peripheral bonds, then overall this could be euro-positive.”

RICHARD MCGUIRE, HEAD OF RATES STRATEGY, RABOBANK:

“The market was not by any means fully priced for this development and you can see that reflected in the very sharp rise in short-dated German yields on the back of today’s move.

“Italy, a couple of basis points tighter, not much of a move. That’s because the ECB is caught between the competing considerations of unexpectedly sharp tightening of policy on the one hand and speculation that the ECB most likely has some kind of credible anti-fragmentation tool it is going to announce.”

PETER KINSELLA, GLOBAL HEAD OF FX STRATEGY AT UBP:

“They have started off with 50 bps which is a very strong move. My view was they would do 50 only if they had a strong plan to deal with Italian spread and leaving the TPI open-ended is a very sensible thing, saying they will step in only if spread developments are blocking the transmission of monetary policy.

“They have been pretty clever in this respect, they have put the Italian situation on ice so markets’ narrative will focus on core rates.

“I think they will do another 50 bps in September and then wait and see. From now it’s really all about normalizing the gas supply situation.”

MARCHEL ALEXANDROVICH, EUROPEAN ECONOMIST, SALTMARSH ECONOMICS, LONDON:

“In the grand scheme of things it (a 50 bps hike) doesn’t change the picture. The ECB had said it wasn’t one or done, given the inflation projection.

“The debate in the market was if they went by 25 now and 50 bps in September. Now markets might think there could be another more 50 bps hike in September.

“We also have the Transmission Protection Instrument (TPI) and that’s going to be as important in terms of market reaction. It is quite vague and not what markets want to hear, it would be good to have more transparency.”

MICHAEL BROWN, HEAD OF MARKET INTELLIGENCE, CAXTON, LONDON:

“I’d say it was marginally more hawkish than expected, though of course long overdue given how behind the curve the ECB are when it comes to taming inflation.

“It will be interesting to see how Lagarde expands on the pace of further policy normalization at the press conference, with markets having already got rather over-excitable in pricing 60 bps of hikes for the September meeting, amid the rapidly narrowing window for further tightening as growth slows rapidly.

“The euro rally in reaction to the larger-than-expected hike is also likely to be short-lived, given said mounting recession risks.”

JOHN DOYLE, VICE PRESIDENT OF DEALING AND TRADING, MONEX USA:

“The decision by the ECB to raise rates by 50 bp instead of 25 bp is not a total surprise especially after comments made earlier in the week. We viewed it as a “toss up”.

“The knee-jerk reaction for Euro strength is the correct one as today’s move slightly closes the gap in policy between the ECB and the U.S. Fed.”

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