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ECB shocks markets with 50bps interest rate hike

business-articlesECB shocks markets with 50bps interest rate hike
The euro spiked on Thursday, initially surging 0.75% against the pound and 0.85% against the US dollar, after the European Central Bank (ECB) raised interest rates by 50 basis points – its first rate rise in over a decade.

Although there had been some speculation about such a steep hike, the hawkish move still surprised markets. The ECB had previously signalled a 25-bp rate rise at this meeting with a larger hike to follow in September.

In its accompanying press release, the bank stated:

‘The Governing Council judged that it is appropriate to take a larger first step on its policy rate normalisation path than signalled at its previous meeting. This decision is based on the Governing Council’s updated assessment of inflation risks’.

After the initial spike, however, the single currency dropped back down. One factor contributing to the reversal was the ECB’s decision to abandon forward guidance. The bank said it would now take a ‘meeting-by-meeting’ approach.

Some economists see this as a dovish development, saying it suggests that the bank believes an imminent recession could prevent it from rate rises in the future.

Carsten Brzeski, Global Head of Macro for ING Research, commented:

‘Hiking rates by 50bp and softening forward guidance shows that the ECB thinks the window for a series of rate hikes is closing quickly.’

Although the bank has opted for a steeper hike now, its terminal rate may be lower than markets had previously priced in.

ECB policymakers also unanimously approved the Transmission Protection Instrument (TPI) – a new tool designed to ensure that the normalisation of monetary policy doesn’t cause instability across different eurozone countries.

Higher interest rates could impact the eurozone economy in a number of ways. One of the more worrying potential effects is fragmentation, whereby borrowing costs rise disproportionately across different countries in the euro area. More debt-stressed states, such as Italy, Greece and Spain, could see the cost of servicing debts skyrocket, which in turn could destabilise the shared currency. The ECB hopes that the new TPI tool will help prevent such an outcome.

However, EUR investors seemed unimpressed by the TPI, and fears of financial fragmentation pressured the single currency.
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