FRANKFURT, Dec 15 (Reuters) – The European Central Bank accelerated the pace of its interest rate hikes on Thursday, but stressed that significant tightening was still to come and outlined plans to drain liquidity from the financial system in part of a relentless fight against galloping inflation.

After being caught off guard by sudden price increases, the ECB raised rates at an unprecedented pace. Inflation has soared since economies reopened after the COVID-19 pandemic, due to supply bottlenecks and then soaring energy costs following the invasion of Ukraine by Russia.

In a similar move this week by the Federal Reserve and the Bank of England, it raised the rate it pays on bank deposits by 50 basis points to 2%, moving further away from a decade of ultra policy. -easy.

The move, which was expected, marked a slowdown in the pace of tightening from increases of 75 basis points at each of the two previous ECB meetings, as price pressures show signs of peaking and a recession is looming.

But to secure a majority for this slowdown, ECB President Christine Lagarde had to offer dissenters a promise that rates would be hiked again, potentially up to three times, by the same amount, sources told Reuters. .

“Based on the information we have today, this predicts another 50 basis points upside at our next meeting and possibly the one after that, and possibly thereafter,” Lagarde said during a briefing. a press conference after the rate announcement.

Money markets immediately priced a record deposit rate of just over 3% in July from 2.75% before the meeting.

The ECB is scrambling to persuade investors of its commitment to fight rising prices after falling behind the Fed and BoE in raising rates.

But this return to giving specific guidance on rates has baffled some ECB watchers as it clashed with the bank’s insistence that it will make decisions “meeting by meeting” and based on data.

“There is an intrinsic contradiction here that no words can resolve,” said Francesco Papadia, a former senior ECB official who is now a member of the Bruegel think tank.

Justifying Lagarde’s commitment to more hikes, new projections from the ECB on Thursday showed inflation above the ECB’s 2% target through 2025.

And Lagarde said inflation could still be higher than that, citing the possibility of stronger-than-expected wage growth and increased demand thanks to government support measures in the 19 countries of the zone. euro.

But those forecasts were decried as “euphemically controversial” by none other than former ECB Vice-President Vitor Constancio, who doubted inflation could stay as high as 3.4% in 2024 even as prices , including oil, were declining.

“The problem, however, is that these December projections commissioned by national central banks (Bundesbank, etc.) have a lot of ‘non-model judgement’,” the Portuguese economist said on Twitter.

The ECB also said it currently expects any recession to be “relatively short-lived and shallow” and Lagarde noted that unemployment levels in the euro were “at an all-time low”.

UPCOMING QTs

The ECB also announced its intention to stop replacing maturing bonds in its 5 trillion euro ($5.310 billion) portfolio, reversing years of asset purchases that have made the central bank the largest creditor to many eurozone governments.

Under the plan, it will cut monthly reinvestments from its €15 billion asset purchase program from March and revise the pace of balance sheet reduction from July.

The move, which is draining liquidity from the financial system, is designed to let long-term borrowing costs rise and follows a similar move by the Fed earlier this year.

The impact was immediately felt by weaker eurozone borrowers, such as the Italian government, which came to rely on the ECB as a major buyer.

The yield on Italian 10-year bonds rose 31 basis points to 4.19%, the biggest one-day change since the pandemic-induced market rout of March 2020.

“The shrinking ECB balance sheet, when combined with larger fiscal spending needs following the current energy crisis, could renew the upward pressure on sovereign bonds in the eurozone,” he said. Daniele Antonucci, chief economist at Quintet Private Bank. , said.

The ECB said it would inform the market on “the end point of balance sheet normalization” by the end of 2023, indicating how much it plans to reduce liquidity in the banking sector.

This is essential to determine the cost of financing for banks and therefore the interest rates for businesses and households.

($1 = 0.9413 euros)

Additional reporting by Yoruk Bahceli; Written by Mark John; Editing by Catherine Evans and Susan Fenton

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