4 conclusions after the ECB hiked the interest rates for the first time in 11 years

By:
on Jul 22, 2022
  • ECB hikes more than expected
  • Forward guidance is dead
  • ECB to remain data dependent

The European Central Bank (ECB)’s decision was the main event of the trading week ending today. Speculation at the start of the week that the central bank would deliver a bigger hike than expected proved correct.

Just like the Bank of Canada and the Federal Reserve, the ECB also hiked by more than the market expected. It delivered a 50bp rate hike instead of the 25bp one.

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So here are four conclusions after the first rate hike in the Euro area in 11 years:

  • All three interest rates were raised by 50bp
  • ECB drops forward guidance
  • ECB to remain data dependent
  • TPI was born

ECB raised the key interest rates by 50bp

Few are aware that when deciding on the interest rates, the ECB decides on the interest for three rates: the main refinancing rate, the marginal lending rate, and the deposit facility rate.

Only one of the three was in negative territory – the deposit facility rate. By lifting the rate by 50bp, the ECB brought it to zero. The other two are now at 0.5% (the main refinancing rate) and 0.75% (the marginal lending rate).

By deciding to move the rates by 50bp, the ECB is effectively frontloading the rate hikes, following the same path as the Fed and other major central banks. On the flip side, by doing so, it dropped forward guidance and, thus, some of its most important assets – its credibility.

ECB drops forward guidance

Forward guidance was one of the best monetary policy tools during deflationary times in the past. By letting the markets know in advance what they will do, central banks avoided unnecessary volatility and tension in financial markets.

But forward guidance is gone, at least for the ECB.

The ECB committed itself to a 25bp rate hike up to the moment when it delivered a 50bp. From now on, markets will take each meeting differently as the guidance is worth nothing from now on.

ECB to remain data dependent

Another key outcome after yesterday’s decision and press conference is that the ECB is data dependent from now on. In other words, it will act based on incoming economic data and not on forecasts. In a way, this is a logical step, given that the central bank consistently missed its inflation forecast in the past several years.

TPI was introduced

A lot of attention was drawn by the introduction of an anti-fragmentation tool by the ECB – the TPI or the Transmission Protection Instrument. It is designed to ensure that the monetary policy stance is transmitted smoothly across all euro area countries and it was approved unanimously by the Governing Council members.

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