The European Central Bank has raised interest rates by half a percentage point, pledging to prevent surging borrowing costs from sparking a eurozone debt crisis amid political turmoil in Italy and the resignation of prime minister Mario Draghi.
It was the first ECB rate rise for more than a decade and twice the size of the increase mooted by the bank only last month. The move ends eight years of negative rates and raises the ECB’s deposit rate to zero.
ECB president Christine Lagarde said it was “time to deliver” after eurozone inflation hit a record high of 8.6 per cent in the year to June, more than four times the central bank’s target of 2 per cent.
The rate increase followed Draghi’s resignation from Italy’s national unity government spanning rightwing, anti-establishment and centre left parties.
It pushes Italy into snap elections and came after the three largest political parties had boycotted a confidence vote. JPMorgan analysts said Draghi had been the victim of a “populist coup”.
Italian stocks and bonds sold off in the aftermath of the resignation and the ECB rate rise, with European policymakers agreeing a new bond-buying programme aimed at countering a surge in borrowing costs for the region’s more vulnerable governments. “The ECB is capable of going big,” Lagarde said, later adding: “We would rather not use [the new programme], but if we have to use it, we will not hesitate.”
The ECB has had to tread a narrow path between responding to inflation and avoiding dragging the region into a recession. The bloc has already been hit by surging energy and food prices following Russia’s invasion of Ukraine, a slowdown in business activity and a drop in consumer confidence to record lows.
Krishna Guha, head of policy and central bank strategy at US investment bank Evercore, said: “The combination of a brewing giant stagflationary shock from weaponised Russian natural gas and a political crisis in Italy is about as close to a perfect storm as can be imagined for the ECB.”
The ECB has been slower than most central banks to respond to rising inflation and is lagging behind the US Federal Reserve, which is next week expected to raise rates by at least 75 basis points, matching a similar-sized move last month.
The euro initially popped on the ECB’s announcement but later trimmed its gains against the dollar to trade at $1.019. Carsten Brzeski, head of macro research at Dutch bank ING, said investors were absorbing the likelihood of the ECB raising rates less than expected in the future after it “weakened its guidance from before” by shifting to a “meeting-by-meeting approach to interest rate decisions”.
Lagarde said the discussions within the bank’s governing council had focused on the need to tackle inflation pressure with a bolder rate rise, while designing a bond-buying scheme to prevent eurozone spreads from widening for “unwarranted” reasons.
The size of bond purchases under the new programme, the “transmission protection instrument”, or TPI, had “no limitation”, Lagarde said.
While support for the programme was unanimous, there was only a “consensus” on the scale of the rate increase.
The political turmoil in Rome has raised concerns about how rising interest rates will affect the sustainability of Italy’s public debt at 150 per cent of gross domestic product.
Italian debt sold off on Thursday, with the yield on the country’s 10-year government bond jumping as much as 0.27 percentage points to almost 3.7 per cent. The decline in Rome’s bond prices meant that the gap between Italian and German benchmark yields — a closely watched gauge of market stress — grew to as much as 2.38 percentage points, reflecting an expansion of more than 0.3 percentage points in just two days. The spread later stood at just over 2.3 percentage points.
The last time the ECB raised rates, under then president Jean-Claude Trichet, it was forced to reverse the move a few months later as the eurozone was gripped by a sovereign debt crisis.
The central bank said rates would rise further in future meetings.
Lagarde said there remained “upside risks” to inflation — code for the possibility that price pressures could remain stronger than the ECB’s forecasts suggest.
The ECB’s rate on its main refinancing operations rose from zero to 0.5 per cent and the rate on its marginal lending facility increased from 0.25 per cent to 0.75 per cent.
The last time it raised rates by half a percentage point was in June 2000, just over a year after the euro’s launch.