The hike is (almost) there! Next: five questions for the ECB

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The headquarters of the European Central Bank (ECB) is pictured in Frankfurt, Germany, January 14, 2021. REUTERS/Kai Pfaffenbach

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LONDON, July 18 (Reuters) – The European Central Bank is set to make its first interest rate hike since 2011 this week, but markets are already moving quickly to focus on a path of higher rates in beyond Thursday as the economic outlook darkens.

This outlook is darkening day by day as inflation continues to accelerate and growth slows sharply.

“The compromise facing the ECB is tougher than any of the other major central banks,” said Silvia Ardagna, head of European economics research at Barclays.

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Here are five key questions for markets.

1. So we’ll get a modest rate hike this week?

Most likely. The ECB will almost certainly rise and it has already announced a 25 basis point (bp) rate hike to contain inflation at a record high of 8.6%. It last raised rates in 2011. Its deposit rate of -0.5% has been negative since 2014. read more

A bigger move of 50 basis points isn’t out of the question, especially given the weakness in the euro, but some analysts say it’s unlikely given growth concerns.

“More than 25 basis points would, in the current situation, be seen by the markets as a very hawkish signal,” said Martin Wolburg, senior economist at Generali Investments.

2. What is the ECB’s plan to contain tensions in the bond market?

The ECB is set to announce a new anti-fragmentation tool in response to a spike in bond yields that has hit the most indebted countries the hardest.

Policymakers are debating whether they should announce the size and duration of a new bond-buying program, sources told Reuters recently. Read more

The announcement of a large envelope could boost confidence in the ECB’s commitment to combating so-called fragmentation risks, but investor disappointment could follow if the size is too small. Meanwhile, a new political crisis in Italy is putting upward pressure on Italian borrowing costs. Read more

“The more robust they design their instrument, the lower the risk of it being tested by the markets,” said UBS’s chief European economist, Reinhard Cluse.

3. What does the weakening growth outlook mean for rate hikes?

Investors will want to know whether a bigger ECB rate hike in September – flagged last month as a possibility – is still on the table, especially as the outlook for growth has deteriorated in recent weeks on fears growing concerns about Europe’s gas supply.

Money markets have started to reduce expectations about the extent of monetary tightening by the ECB, and analysts believe that the ECB’s window of opportunity may close sooner than expected.

“A weaker economic outlook will affect the ECB’s tightening path,” said Wolburg of Generali Investments, whose base scenario for the deposit rate is 1.25% by the end of 2023.

4. Does the ECB expect a recession?

The ECB’s next set of economic forecasts will be released in September, but its director, Christine Lagarde, will no doubt be asked about her views on the outlook.

Thursday’s meeting coincides with the end date of the annual maintenance of the largest gas pipeline carrying Russian gas to Germany. Fears that Russia will cut gas supplies to Europe have heightened recession fears.

The European Commission now expects the eurozone economy to grow 1.4% next year from 2.3% previously. Read more

“They (the ECB) will recognize that a recession is a case of reasonable risk, but it’s not their base case at this point,” said Andrew Mulliner, head of global global strategies at Janus Henderson.

5. Is the ECB worried about the weakness of the euro?

The fall of the euro to parity against the dollar for the first time in two decades poses a problem for the ECB. Dropping the currency exacerbates inflation, already well above its 2% target. A more hawkish stance to support the currency, or faster rate hikes, could hurt growth.

But moves to boost the euro are seen as unlikely.

“They know that being caught in this loop of trying to prop up your currency through central bank actions is quite dangerous because you have to overtighten, which hurts the economy and the currency,” he said. said Janus Henderson’s Mulliner.

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Reporting by Dhara Ranasinghe in London and Stefano Rebaudo in Milan Editing by Tommy Reggiori Wilkes and Catherine Evans

Our standards: The Thomson Reuters Trust Principles.

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