ECB delivers rate hike, adds tool to its box

FRANKFURT – The European Central Bank decided Thursday to raise interest rates by half a percentage point, more than flagged, to tame the record inflation that has sparked a massive cost of living crisis across the region.

“The Governing Council decided to raise the three key ECB interest rates by 50 basis points,” the ECB said in a statement. Taking effect next Wednesday, the interest rate on the main refinancing operations, the marginal lending facility and the deposit facility will be increased to 0.50 percent, 0.75 percent and 0.00 percent, respectively.

The ECB is lagging most of major central banks in its fight against inflation. Thursday’s move aligns the ECB more closely with its peers, which have moved in 50 and 75 basis point steps. It comes in response to scorching inflation in the eurozone, which climbed to record high 8.6 percent in June.

The Governing Council “judged that it is appropriate to take a larger first step on its policy rate normalization path than signalled at its previous meeting” in view of its updated inflation outlook, the statement said.

Looking ahead, “further normalization of interest rates will be appropriate,” with the future rate path to be decided meeting-by-meeting hinging on incoming data, it said.

In addition to the changed inflation outlook, the Governing Council thought a bolder hike was possible due to the completion of its new “tool,” which is aimed at limiting sovereign debt jitters as it continues to normalize policy, it said.

With Italian Prime Minister Mario Draghi set to resign, Rome’s fresh political crisis is sending shock waves through eurozone sovereign bond markets, which could result in excessive tightening of monetary conditions in some member states. That could make it harder for the ECB to raise rates and deliver on its price stability mandate.

The spread between Italian and German ten-year bonds widened to 239 basis points on news of Draghi’s announcement.

Policymakers considered the new tool, dubbed Transmission Protection Instrument (TPI), as necessary to support the effective transmission of monetary policy.

“In particular, as the Governing Council continues normalizing monetary policy, the TPI will ensure that the monetary policy stance is transmitted smoothly across all euro area countries,” it said. “The singleness of the Governing Council’s monetary policy is a precondition for the ECB to be able to deliver on its price stability mandate.”

The new instrument can be activated to counter unwarranted market disruption that poses a serious threat to the transmission of monetary policy, the statement said. There will be no ex-ante limits to purchase bonds, and the scale will depend on the severity of the risks facing policy transmission.

ECB President Christine Lagarde is due to start her press conference shortly explain the decision. Ten years ago almost to the day, Draghi promised to do “whatever it takes” to safeguard the integrity of the currency union. Today, the onus is Lagarde.

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