The ECB is heading to a critical meeting in July with a rate rise expected and investors awaiting details of its new fragmentation tool.
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A member of the European Central Bank told CNBC Wednesday that there’s plenty of runway to hike interest rates, following the two planned raises for July and September.
All eyes are on the ECB with a critical meeting next month. The euro zone’s central bank has said it will be raising interest rates for the first time in 11 years, but investors are more interested on whether President Christine Lagarde‘s team will be able to further tighten monetary policy over the medium term.
The ECB has said there will be another hike in September, but doubts currently rest on the period after that — given that the economic prospects of the bloc are darkening. Raising interest rates could slow down economic growth further.
“We will have to make an assessment where the economic development is going and where inflation stands and afterwards there’s ample room to hike in 0.25 and 0.5 levels to whatever rate we think, we consider reasonable,” Robert Holzmann, who’s also the governor of the Austrian central bank, told CNBC about the period after September.
At the moment, the central bank has to somehow manage record levels of inflation and a worsening economic outlook. The ECB forecast in June a 2.8% growth rate for the euro zone this year, but there are growing concerns that this will not materialize, with the war in Ukraine adding continuous economic pressure on the bloc.
The ECB’s Chief Economist Philip Lane has previously stressed that the ECB has to manage two major risks.
“On the one side, that could be forces that keep inflation higher than expected for longer. On the other side, we do have the risk of a slowdown in the economy, which would reduce inflationary pressure,” he told CNBC Tuesday.
But, according to Austria’s Holzmann, “there are indications that towards autumn, we might have peak inflation.”
ECB forecasts do point to a slowdown in consumer price rises from this year to the next, with headline inflation moving from 6.8% to 3.5% in 2023. However, there is plenty of uncertainty attached to these estimates with the war in Ukraine dragging on, the energy crisis accelerating and food supply shortages pushing up the cost of living.
Investors have started to worry about fragmentation risks in the euro zone too.
The central bank held an emergency meeting earlier this month to address a surge in borrowing costs for the so-called peripheral European nations. The ECB said it would be developing a new tool to address these risks — however, markets were left wondering when the tool would be implemented and how far it would go.
Speaking to CNBC at the ECB Forum in Sintra, Portugal, Mario Centeno, also a member of the central bank, said: “We are looking to design what we call a backstop that will help us with the normalization.”
Since the ECB outlined its intentions to raise interest rates in July and September, marking a shift in its policy, investors have questioned whether highly indebted nations, such as Italy and Greece, would get into trouble with their borrowing costs. The ECB’s upcoming fragmentation tool is meant to address these issues, by telling investors in general terms that they do not need to worry about these debt piles.
Centeno said the tool is “precautionary for sure,” and they do not see any “actual fragmentation in the market.”
Constantinos Herodotou, the governor of the Central Bank of Cyprus, who also joined CNBC Wednesday, said there had been “no final decisions yet” on the fragmentation tool.
The ECB’s next meeting is on July 21. However, Herodotou defined the aim of this new policy tool that’s being prepared.
“If there is unwarranted fragmentation which means that it is not based on economic fundamentals but then it has to be big enough and strong enough to be effective, but at the same time have within its design the ability to avoid any moral hazard issues,” he said.