ECB hawk raises prospect of steeper rate increase in July

A top European Central Bank official has raised the prospect of a half percentage point interest rate increase in July if inflation continues to climb, the first time such an aggressive shift has been mooted.

Tuesday’s comments by Dutch central bank chief Klaas Knot, one of the more hawkish members of the ECB’s rate-setting body, sent ripples through financial markets, as the euro rose 1.1 per cent against the US dollar to $ 1.0546 and eurozone government bond prices fell.

ECB president Christine Lagarde has signalled that the bank’s first rate rise for more than a decade is likely to occur at July’s governing council meeting. But she and many other policymakers have stressed they will move only “gradually” – indicating any change to rates will be in quarter-point increments.

Knot’s comments make him the first ECB governing council member to say it could raise its deposit rate by half a percentage point in July. That would take the rate from minus 0.5 per cent to zero in a single move.

“Based on current knowledge, my preference would be to raise our policy rate by a quarter of a percentage point – unless new incoming data in the next few months suggests that inflation is broadening further or accumulating,” he told Dutch TV program College Tour. “If that is the case, bigger increases must not be excluded either.”

Knot added: “In that case a logical next step would amount [to] half a percentage point. ” Eurozone inflation for April reached 7.5 per cent – well above the ECB’s target rate of 2 per cent – and price pressures are continuing to build because of the fallout from Russia’s invasion of Ukraine and China’s coronavirus lockdowns.

“This is the first such statement challenging the ECB’s commitment to gradual tightening,” said Frederik Ducrozet, a strategist at Pictet Wealth Management. “Now this is also a proposal that the doves can oppose. I would watch their reaction closely in coming days. “

The ECB last raised rates in 2011, a move subsequently considered a mistake by many economists, since it prefigured the EU’s debt crisis. This time around, many of its officials – particularly southern European “doves” – emphasize the importance of proceeding with caution owing to the risk of a eurozone recession.

European government bonds declined in tandem with the euro’s rise following Knot’s comments, with the 10-year German Bund yield up 0.08 percentage points at 1.02 per cent.

Expectations for ECB rate rises also ticked up, with money markets signalling expectations that the central bank will raise rates by 1 percentage point this year, from about 0.93 percentage points the previous day, according to Bloomberg data.

The single currency has come under intense pressure this year on expectations the US Federal Reserve will tighten monetary policy much more quickly than the ECB and some eurozone policymakers worry that a weaker euro will fuel more inflation by raising import prices.

The Fed raised its benchmark policy rate this month by half a percentage point for the first time since 2000 and sent a strong signal that it intended to increase it by the same amount at the next two meetings.

But other monetary authorities, such as the Bank of England, have been more cautious in raising rates by a quarter percentage point at a time. Lagarde said last week that given growing uncertainty about growth, the ECB would pursue “gradualism concerning the pace of monetary policy adjustment”.

Kit Juckes, a macro strategist at Société Générale, said the ECB was unlikely to raise rates more than a quarter percentage point in July, adding: “That doesn’t mean there won’t be people in the room alarmed by how much inflation there is. “

Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, said faster than expected rate rises by the ECB would support the euro. However, he added: “The outlook on the euro-dollar is bearish because of Ukraine. If we get more news of an oil or gas embargo, or an acceleration of the invasion, this will weigh on the euro disproportionately. “

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