Interest rates

ECB exits negative interest rates, hikes 50 percentage points, doubles pledge, bigger increases possible, shows new glue gun to prevent sovereign debt crisis during rate hikes and QT

Soaring inflation eventually forces the ECB to abandon its reckless and absurd monetary policies and become hawkish.

By Wolf Richter for WOLF STREET.

The ECB made two big announcements following its meeting today, July 21, 2022, and we will set this date in stone because it is so important in the absurd NIRP fiasco:

First, the ECB finally exited its negative interest rate policy (NIRP) by increasing all its key rates by 50 basis points, including its deposit rate, which was the negative rate, to -0.5% . This deposit is now 0.0%, and there are no more negative rates at the ECB.

And second, he showed off a new glue gun – the Transmission Protection Instrument or TPI – designed to prevent a sovereign debt crisis and keep the eurozone together, even got the ECB to raise rates and reduced its balance sheet (quantitative tightening or QT) to fight galloping inflation.

Rate hikes: RIP NIRP.

The ECB announcement today that it would raise its three key rates by 50 basis points.

These rate hikes were the first since 2011. And they were the largest since June 2000 and November 1999, when the ECB was still seen as a guardian of a hard currency, rather than a reckless money printer. , an inflation arsonist and an absurd NIRP.

From July 27, the ECB will increase its:

  • Deposit rate, from -0.5% currently, to 0.0%. RIP NIRP.
  • Main refinancing rate, currently 0.0%, to 0.5%
  • Marginal lending rate, currently 0.25%, to 0.75%

The ECB has also put more and bigger rate hikes on the table, the next round of which will arrive at its September meeting.

The ECB had committed in its previous communications to raise its key rates by 25 basis points today. Thus, today’s 50 basis point rate hikes have been called a “surprise”.

But they weren’t much of a surprise since there was a lot of talk of bigger hikes from ECB Council members, including ECB Council member Robert Holzmann, who said on July 9 that a 125 basis point hike in September might be necessary. , if the inflation outlook does not improve. They are all now talking about big rate hikes. They want the world to take them seriously.

So this reckless and nonsensical pacifist attitude at the ECB has now gone out the window, given the explosion of inflation that the ECB has in its hands.

Grappling with the raging inflation fiasco.

Across all 19 eurozone countries, CPI inflation hit 8.6% in June, heading towards 10% as things stand. But it is even more horrifying in a number of Member States: in nine Member States, CPI inflation is already 10% or more, with a maximum of 22%.

CPI inflation started to rage in March 2021almost a year before the war in Ukraine, exceeded the ECB’s target in July 2021 and continued to climb to reach 5.9% in February 2022.

These are scary, crazy inflation numbers, and the ECB has been the most reckless central bank among developed economies, considering how long it spent on its silly NIRP and kept printing money, even as inflation raged and exploded and spun out of control:

TPI, the fancy glue gun to keep the Eurozone together while raising rates and doing QT,

If this glue gun works as advertised, it would allow the ECB to track rate hikes and the QT, and continue to do so until the inflationary spiral is brought under control, without being distracted by a crisis in the sovereign debt and the threat that the euro zone will lose a member or two because some hedge funds have decided to get involved.

The fundamental problem in the Eurozone is that individual member states cannot print problems themselves and cannot devalue their currencies to solve their internal fiscal problems. They ceded these functions to the ECB, and the ECB must keep these 19 countries in the monetary union, come hell or high water.

One of the ways in which the monetary union could break up would be if a fiscally “weaker” country, such as Greece, Italy or Spain, lost market confidence and faced a surge. yields on its sovereign debt, to the point where these countries find it difficult to borrow new money to repay maturing debts and finance current account deficits and interest payments, while the yields on the German debt would remain relatively low.

This is what happened during the Eurozone debt crisis, which was resolved by a promise of money printing and NIRP from the ECB.

Now there is a different problem, galloping inflation: Greece (12%), Spain (10%), Italy (8.5%) and Germany (8.2%). The ECB needs to tighten its monetary policies to bring this situation under control, which includes rate hikes and asset write-offs (QT).

As soon as this tightening appeared a few months ago, the spread between the yields of German bonds and equivalent Italian bonds began to widen, and fears arose of a “fragmentation” of the euro zone, if, for example, the Italian 10-year yield were to drop to 10% while the German 10-year rate would only go to 4%, and Italy would then no longer have the means to borrow, would default on its debts, ditch the euro and go back to the lira or whatever.

To prevent this scenario from happening, the ECB has come up with its new glue gun: the Transmission protection instrument. It basically says that the ECB can target the bonds it allows off the balance sheet and the bonds it buys, based on the yields of weaker countries.

For example, if Italian yields start to explode, the ECB can buy Italian bonds, but leave German, French, Austrian and Dutch bonds off its balance sheet, while keeping its overall QT on track.

There are a few special features on this glue gun:

The ECB hopes that the mere presence of the tool will maintain the behavior of the markets so that the ECB will not even have to use the tool. The tool is a way to keep the markets from going haywire.

But if the yield spread explodes for reasons the ECB says are due to “country fundamentals,” rather than markets going haywire, that may “end” bond buying, and the country should determine for itself how to restore confidence in the markets, to lower yields.

The ECB will accept a yield differential, for example between German bonds and Italian bonds, but within certain limits, which has always been the case.

When the ECB decides to reduce its balance sheet as a policy (QT), it will do so even if it has to apply the TPC as part of the balance sheet reduction. This could mean that if Italian yields threaten to explode, the ECB could buy Italian bonds, but let its holdings of bonds issued by other countries drain faster, so that the overall balance sheet reduction continues as intended.

The ECB has established a long set of rules and conditions when a country would be eligible for this PTC and when it would not be. These conditions include that countries must keep their debts on a “sustainable” path and must have “sound and sustainable macroeconomic policies”. And if yields jump due to “country fundamentals,” the ECB may end TPC asset purchases.

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