FRANKFURT—The European Central Bank is likely to increase its key interest rate, currently negative, to zero by September and could continue raising rates after that, President
said, signaling the end of the ECB’s eight-year experiment with negative rates amid record-high inflation and concerns about the weakness of the euro currency.
The policy shift, outlined in an ECB blog post on Monday, follows robust actions by the Federal Reserve and other major central banks to phase out easy-money policies as inflation heats up around the globe. It is part of a sharp pivot by the eurozone central bank, which had until recently signaled it would increase interest rates only gradually, diverging from the Fed.
ECB policy makers had expected inflation to fall back rapidly to their target of 2% this year. Instead, it rose higher, reaching 7.4% in April, the fastest pace since the euro was created in 1999. They had also been reluctant to aggressively raise rates because of concerns about the shock to economic growth from the war in Ukraine, which risks tipping the region into recession.
Despite these considerations, Ms. Lagarde wrote that the ECB could increase its key interest rate in July for the first time in 11 years. “Based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter,” Ms. Lagarde wrote in the post published on the ECB’s website. The ECB’s key rate is currently set at minus 0.5%.
“With the inflation outlook having shifted notably upward compared with the prepandemic period, it is appropriate for nominal variables to adjust—and that includes interest rates,” Ms. Lagarde wrote.
The euro jumped by almost a cent against the dollar after the blog was published, and was trading at about $1.068. Yields on Italy’s 10-year government debt also jumped. Yields rise as prices fall.
It is the first time that Ms. Lagarde has signaled such an aggressive interest-rate trajectory. She had previously indicated that the ECB might start increasing interest rates in July and that any further increases would be gradual.
After September, Ms. Lagarde suggested the ECB would continue raising rates toward the so-called neutral interest rate, which supports the economy at maximum output while keeping inflation constant. Some ECB officials have estimated that the eurozone’s neutral rate could be around 1% or 1.5%.
The comments suggest that the ECB could raise its key rate by 0.25 percentage point at each of its seven meetings between this July and April next year, reaching a level of 1.25%, according to Michael Schubert, an economist with
François Villeroy de Galhau,
who sits on the ECB’s rate-setting committee as governor of France’s central bank, said Monday that a deal for near-term ECB interest-rate increases was “probably done,” pointing to a broad rise in prices in the eurozone.
“We are still releasing the accelerator,” Mr. Villeroy de Galhau said of the ECB’s policy setting, on a panel at the World Economic Forum in Davos, Switzerland. “We will see if after [reaching] the neutral [interest] rate we have to press the brake.”
A series of interest-rate increases pose risks for the eurozone economy, which hasn’t completely recovered from the Covid-19 shock. The war in Ukraine has undermined household incomes by pushing energy and food prices even higher and reduced business confidence.
But pressure on the ECB has been building, including in Germany, Europe’s largest economy, where annual inflation recently hit a four-decade high of 7.4%. Germany’s Finance Minister Christian Lindner warned on Friday that a weak euro might be driving up inflation in Europe and encouraged the ECB to increase interest rates, an unusual step for a nation that normally prizes central-bank independence.
Across the Atlantic, the Fed is raising interest rates as part of its most aggressive effort in decades to curb upward price pressures. Fed officials approved a rare half-percentage-point interest rate increase earlier this month, the largest since 2000, and a plan to shrink its $9 trillion asset portfolio. That lifted the central bank’s benchmark federal-funds rate to a target range between 0.75% and 1%.
said officials broadly agreed that additional half-point increases could be warranted in June and July given current economic conditions.
Ms. Lagarde indicated that the ECB is prepared to act more aggressively if needed. “If we were to see higher inflation threatening to de-anchor inflation expectations, or signs of a more permanent loss of economic potential that limits resource availability…we would need to withdraw accommodation [or phase out easy-money policies] promptly to stamp out the risk of a self-fulfilling spiral,” she wrote.
The last time that the ECB increased interest rates, in 2011, it moved in increments of 0.25 percentage point. Some ECB officials have suggested recently that the ECB could move more aggressively this time, perhaps raising rates by 0.5 percentage point at its July 21 policy meeting.
The surge in eurozone inflation partly reflects Russia’s invasion of neighboring Ukraine, which has disrupted Europe’s energy supplies and pushed the region’s energy burden as a percentage of gross domestic product above levels reached in the early 1970s, according to calculations by
Record-high inflation also partly reflects a weak euro, whose value against the dollar has suffered from the ECB’s reluctance to increase interest rates. The euro has fallen close to parity against the dollar in recent weeks and, until Ms. Lagarde’s comments on Monday, was trading at around $1.05, down from about $1.22 a year ago.
A weak euro has both pros and cons for Europe. It makes the region’s exports cheaper in international markets, supporting large exporters in Germany and elsewhere. But it also makes imports to the eurozone more expensive and thereby pushes up inflation. If the euro’s value declines against other currencies, more euros are needed to purchase goods denominated in those currencies. That is especially true as inflation is being driven primarily by energy and commodity prices, which are often invoiced in U.S. dollars.
In her blog post, Ms. Lagarde warned that a large share of eurozone inflation was imported from outside the region.
“This is acting as a terms of trade ‘tax,’ which reduces the total income of the economy—even if we take into account the higher prices being earned by exporters,” she wrote. The eurozone transferred €170 billion, equivalent to $181.14 billion, or 1.3% of its gross domestic product, to the rest of the world between the second quarter of 2021 and the first quarter of this year, she wrote.
The ECB is among a handful of central banks to have pushed a key interest rate below zero in recent years to give their economies an extra kick. Some economists and ECB officials have long warned that the unorthodox tool could create distortions in financial markets and the economy.
Write to Tom Fairless at email@example.com
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