Dutch central bank chief raises prospect of 0.5% ECB 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.

The 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, with the euro rising 1.1 per cent against the dollar to $1.0546 and euro zone government bond prices falling.

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.

Prof Knot’s comments make him the first ECB governing council member to say the bank 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.

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“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 programme College Tour. “If that is the case, bigger increases must not be excluded either.”

Prof Knot added: “In that case, a logical next step would amount to half a percentage point.”

Inflation rate

Euro zone 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 due to 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” – emphasise the importance of proceeding with caution due to the risk of a euro zone recession.

European government bonds declined in tandem with the euro’s rise following Prof 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 risen, with money markets signalling expectations that the central bank will raise rates by one 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 euro zone 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. Ms Lagarde said last week that given growing uncertainty about growth, the ECB would pursue “gradualism concerning the pace of monetary policy adjustment”. – Copyright The Financial Times Limited 2022