As Italy lurches towards crisis ECB builds new bond backstop in trade-off for higher rates

Another half-a percentage point rate hike – or higher – could be on the cards for September, the European Bank has signalled, as it scrambles to tame near double-digit inflation.

political crisis in Italy, the bloc’s third largest economy, has also put pressure on the ECB to row in to calm bond markets now that its pandemic purchases have ended.

President Christine Lagarde said the bank is “capable of going big” to dig out countries that might feel the hit from the change in policy, via its newly created transmission protection instrument (TPI).

Last month the ECB hinted it would increase its main lending and deposit rates by a quarter point this month, while going higher in September.

Today, all 25 ECB governing council members agreed on a 0.5pc boost to all the main rates – the first rate hike in 11 years, which lifts deposit rates out of negative territory for the first time since 2014.

“The two of them were clearly a package,” Ms Lagarde said of the pair of rate rises. “The combined forward guidance that existed for September is no longer applicable.

“Having weighed the pros and cons, we decided, on balance, that it was appropriate to take a larger step towards exiting from negative interest rates.”

She said a decision in September would depend on the “data”, with the bank aiming to arrive at its 2pc inflation target over the medium term.

“That doesn’t meant to say we are changing the ultimate point of arrival. We are accelerating the exit and we are following the path of normalisation that we have flagged,” she said.

A higher-than-expected rate rise was a trade-off for creating the TPI, which is in theory open to all soon-to-be 20 euro members.

It would see the bank buying up bonds in countries that face “unwarranted disorderly market dynamics”. It will be up to the ECB to decide whether a sufficient shock has taken place.

However, the TPI comes with conditions, with beneficiary countries having to stick to European Commission-approved economic reform plans and debt reduction targets.

Ms Lagarde would not be drawn on whether the ECB will soon start buying Italian bonds.

“The singleness of our monetary policy is a precondition for the ECB to be able to deliver on its price stability mandate,” she said.

“TPI will help us deliver on our mandate of price stability, bringing inflation in the medium term back to 2pc.

“If we have to use it we will not hesitate,” Ms Lagarde said.

Prices in the eurozone rose 8.6pc in June, year on year, with inflation in Ireland creeping up to 9.6pc in the wider EU and in Ireland.

The ECB feared that faster-rising energy and food prices – as well as expectations of further rises, leading to higher wage demands – would spiral out of control if it did not act faster to tame demand.

Other major central banks began their rate hiking path late last year or early in 2022.

However, the resignation of Italian premier Mario Draghi – a former ECB president credited with stabilising the euro during the last financial crisis – has thrown a spanner in the works, threatening to drag down eurozone growth even further and shake bond markets.

“This decision shows that the hawks must have got cold feet, fearing that the promised higher-than-25bp rate hike in September would be washed away by the looming recession,” said Carsten Brzeski, ING’s global head of macro.

“The agreement on a TPI had to be paid for by the doves with a stronger rate hike.”

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