A euro currency symbol is on display in the Visitor Center of the European Central Bank (ECB) building in Frankfurt, Germany.
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The European Central Bank’s policy makers are eager to end their bond buying scheme as early as possible and raise interest rates as soon as July, but certainly not later than September, nine sources familiar with the ECB’s thinking told Reuters.
The ECB has removed the stimulus at the slowest possible pace this year, but a rise in inflation is now putting pressure on policy makers to end their nearly ten-year experiment with unconventional support.
The major obstacle so far has been that long-term forecasts still show that inflation fell back below the ECB’s 2% target, but new estimates shared with politicians at their meeting on 14 April showed that even 2024 inflation exceeded the target, several of the sources.
“It was a little over 2%, so according to my interpretation, all the criteria for raising interest rates have now been met,” said one of the sources, who asked not to be mentioned.
Members of the Governing Council have long criticized the ECB for underestimating inflation, which hit 7.5% last month, and they see the new projection as a step towards acknowledging reality.
“When (chief economist) Philip (Lane) presented the numbers, people were actually clapping,” another source said.
An ECB spokesman declined to comment.
No policy proposals have yet been submitted and the next meeting of the ECB is still over a month away, on 9 June.
ECB President Christine Lagarde said on Friday that bond buying should end early in the third quarter and a rise in interest rates this year is likely.
Nearly all sources said they see at least two rate hikes this year, but some argued that a third is also possible, although it is highly dependent on how markets digest its movements.
Markets are pricing around 85 basis point increases for this year, so more than three 25 basis point movements, which would bring minus 0.5% deposit rate back into positive territory for the first time since 2014.
Settlement stimulus, the ECB has long argued that it is merely to normalize policy, is an undefined concept without fixed parameters.
However, the political decision-makers who spoke to Reuters said that normalization should mean returning to the neutral interest rate, which neither stimulates nor holds back growth.
They set this at around 1% to 1.25%, then 150 to 175 basis points above the current interest rate.
“Reaching this level by the end of 2023 could be reasonable,” said a fifth source.
However, interest rates can only rise when bond purchases are completed, and all 9 politicians who spoke on condition of anonymity said this should happen on June 30 or July 1.
This would mean that the ECB, at its meeting on 21 July, would be able to raise interest rates.
“Unless the outlook changes dramatically, I would go after July,” said a third source.
However, some sources said they would still prefer to wait until September, partly because new forecasts would be available before then, and partly to avoid a major political drag in the summer months, when liquidity is lower.
Most recently, the ECB raised interest rates in 2011 on the eve of the bloc’s debt crisis, a move that is now widely considered to be its biggest political mistake to date.
“The memory of that trait still haunts us,” said a fourth source. “Some people fear making a similar mistake.”
The US Federal Reserve is expected to tighten even faster. Markets are seeing a tightening of almost 250 basis points this year with increases of 50 basis points at some meetings.
However, all the ECB’s policy makers stressed that the outlook may change radially until then, as Russia’s invasion of Ukraine is a persistent threat to confidence, and the COVID-19 pandemic is not over either.
Some policy makers said a technical recession or two consecutive quarters of negative growth is possible this year, but the figure for the full year will still be positive.