“ECB Raises Interest Rates and Continues Tightening Monetary Policy to Eradicate Euro Area Inflation”

Still in the first months of the year, in the European Central Bank there was widespread expectation that rates would rise again in May and June. But they would do it more slowly than the forced hikes of the fall and winter, and then stop. At least this is the scenario that many in and around the ECB considered probable. Not anymore: now such a path, according to the majority in the Frankfurt Governing Council, does not go far enough and does not guarantee eradicating inflation from the euro area quickly enough.

When you present the Governing Council’s decisions in Frankfurt tomorrow, Christine Lagarde he will therefore probably give at least two messages. The first will be very tangible: it concerns a new increase in interest rates which, barring improbable surprises, will be decided this week and could be 0.25% or even 0.50%. But the second message from the president of the ECB will be followed with even more attention. Faced with inflation falling more hesitantly than many had imagined, Lagarde will make it clear that the ECB is now thinking of continuing to raise rates even after the increases this week and next month. There are unlikely to be any advance announcements. Lagarde will not tie his hands on the next steps in the monetary tightening, as he did late last year for his moves through March. The indications of the president will be more vague, but the current intentions are clear: in the ECB many want to continue the tightening at least until late summer; before next autumn the banks could pay interest of more than 4% (against the current 3.5%) to refinance themselves at the main counter of the issuing institution. The central bank has not practiced that level since July 2008, on the eve of the Great Financial Crisis.

But the fight against inflation will not only take the classic form of a continued series of rate hikes. In June, the ECB could decide to slow down even more the buybacks of government bonds bought between 2015 and 2019, as these mature and are repaid. For now, the central bank is reducing its accumulated investment portfolio by $15 billion a month at rates of up to $80 billion a month when Mario Draghi was president. The deal is proceeding smoothly and the spread on ten-year bonds between Germany and Italy, the weakest link in the euro chain, has even fallen in the last six months of monetary tightening and liquidation of ECB investments. But before long it could accelerate the pace at which the central bank reduces the legacy of quantitative easing from its balance sheet. Some members of the Governing Council would like to completely stop the buybacks, upon expiry, of the card purchased up to 2019. There are those who are thinking of doing the same in 2024 with 1,850 billion in interventions launched during the pandemic.

In essence, the times in which Italy could count on the massive support of the ECB in order to secure demand for its public debt are increasingly distant. Today in Frankfurt the idea prevails that the enemy to beat is inflation, with the utmost determination. And if this were to open up financial stability problems, on some government bonds or in the private sector, the central bank today does not think of stopping because of this. The ECB believes it can always manage emergencies by guaranteeing liquidity to subjects who come under pressure. But rates must now go up.

The last few months have shown that this is not an impossible path for Italy, on one condition: that ECB rates do not remain high for long. Average interest rates of around 4% offered on Rome bonds to be sold for the rest of 2023 and throughout 2024 would unbalance the state accounts. This is also why it is important that inflation starts to fall, so that the ECB can soon return to reducing rates. And yesterday the cost of living in the euro area net of energy and food – the value that Frankfurt looks at the most – hinted at its first, tiny drop to 5.6%. But since the goals are still far away, the game remains more open than ever.