Aurelia Butler

The ECB raised interest rates to a 22-year high of 3.50% on Thursday and said it would move again in July, continuing what has been the fastest pace of monetary tightening in the bank’s quarter-century existence.No policymaker took a firm stance on rate action beyond July, but several hinted that the ECB may need to keep going.”We still have more ground to cover,” Bundesbank President Joachim Nagel said in a speech. “We may need to keep raising rates after the summer break.”Belgian policymaker Pierre Wunsch, who was among the first to recognise the ECB’s inflation problem, argued the bank would need to see a “substantial” drop in underlying inflation, which filters out volatile energy and food prices, not to raise rates in September.”If core keeps at around 5% on a yearly basis in the coming months, then we will increase beyond September,” he added.”If we look at the smoothed monthly numbers, they have been around 0.4% a month for over a year,” he said. “We don’t really see a beginning of slowdown there.”Underlying inflation eased to 5.3% in May, but a big chunk of the drop was due to a one-off administrative discount in German transport prices. Wunsch has said in the past that the ECB’s deposit rate could hit 4% if underlying inflation did not moderate. On Friday he said that conditions for such a rate are materialising. Austria’s Robert Holzmann, one of the most outspoken policy conservatives, kept his powder dry on Friday, arguing that it was too soon to say whether further hikes beyond July are needed.Lithuania’s Gediminas Simkus pushed back on market expectations for early 2024 rate cuts, saying that such a rapid reversal would be puzzling.The ECB has long said that once rates peak they would stay there for an extended period, but markets have always doubted this, mostly because they expect the U.S. central bank to start cutting rates, which could then force the ECB’s hand.Markets have now fully priced in one more rate hike and see a high probability of a second move to 4% by October, even if uncertainty remains.The repricing comes as a host of bank analysts raised their expectation for the ECB’s terminal rate to 4%. Joining the chorus behind rate hikes, Estonian central bank chief Madis Muller said more rate action is needed.”Euro zone interest rates have not yet peaked,” Muller said in a statement. “The ultimate goal is clear for the central bank – we need to quickly get the price rise under control.” More

Turkey’s new central bank governor is expected to double interest rates next week, as the country’s fresh finance team attempts to stabilise the battered economy.Business executives and analysts expect Turkey’s main interest rate to be hoisted to 17 per cent from 8.5 per cent when the monetary policy committee meets next week, with Hafize Gaye Erkan at the helm for the first time, according to a central bank survey published on Friday. Steering Turkey towards a sustainable economic path will require a sharp rise in borrowing costs and a further lira depreciation, with the country’s foreign currency war chest “dangerously” depleted by unorthodox policies and at least $23bn used to prop up the lira before May’s election. The financial leadership drafted in by Recep Tayyip Erdoğan since his re-election last month, led by Erkan and recently appointed finance minister Mehmet Şimşek faces mounting challenges as they seek to pull the $900bn economy from the brink.Analysts and executives also expect the lira to plunge another 17 per cent over the next 12 months, according to the survey, after already tumbling 64 per cent since this time in 2021 as the government eases its efforts to slow its fall. “[A turnround would] not be easy to achieve since recent economic policies created significant anomalies,” said a senior analyst at the Turkish branch of an international financial group. “Even if they want to return to orthodox policies, those steps may create side-effects.” Erdoğan’s flagship economic programme, focused on keeping borrowing costs low despite acute inflation and defending the lira, has caused severe imbalances and sent foreign capital fleeing. The use of unconventional tools accelerated ahead of elections as Erdoğan deployed government resources to boost the economy, including giving away free gas and lifting the minimum wage. Some $23bn was also spent supporting the lira between the start of 2023 and May’s second-round elections, according to calculations by economist Haluk Bürümcekci, which exclude other interventions to help ease the currency’s fall in recent years. Erich Arispe, the primary analyst responsible for Turkey’s government credit rating at Fitch Ratings, said: “The build-up of distortions and the increase in vulnerabilities as a result of the election stimulus may call for at least a tactical shift in terms of economic policy direction.”

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Erdoğan said this week that while he had not changed his mind on the unorthodox view that high interest rates caused rather than cured inflation, he would allow Erkan and Şimşek to take steps to bring inflation to single digits from the current level close to 40 per cent. Şimşek, a former deputy prime minister well regarded by foreign investors who has vowed to restore “rational” policies in Turkey, has yet to disclose specific policy details. But analysts say the lira’s 16 per cent tumble against the dollar to new record lows since the May 28 vote was a sign that Turkey has begun intervening less aggressively in the currency market. He has said his priorities include narrowing the country’s yawning current account deficit, which has been caused in large part because goods imports significantly exceed exports. The deficit was $29.7bn in the year to April, the highest level on record.

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The overvalued lira and an overheating domestic economy have been partly to blame. Gold purchases from abroad by locals fearing further currency falls have fed the widening trade gap. The current account deficit has been financed in large part through the central bank’s foreign currency reserves. Reserves had also been spent defending the lira, a policy that was “not sustainable”, said Clemens Grafe, an economist at Goldman Sachs. Turkey’s official reserve assets amount to $99.8bn, including $50.3bn in foreign currencies and $42bn in gold, according to central bank data. But this does not include the amounts the central bank owes to locals and foreigners. Net foreign assets, a proxy for foreign exchange reserves that is closely watched by investors, were minus $15.9bn, a figure that would be even lower if not for tens of billions of dollars of funds borrowed from the local banking system and foreign central banks through tools known as “swaps”. Turkey’s net foreign assets are in an even worse position than after the 2000-01 Turkish banking crisis, during which the lira collapsed and interest rates soared, central bank data showed. “Current levels are dangerously low and it requires efforts to rebuild foreign currency reserves,” said Christian Wietoska, a Deutsche Bank strategist.

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Economists expect several actions in quick succession will be needed to begin turning round the economy. “Stabilising the economy will require a large, and we think discontinuous, adjustment to the exchange rate,” Grafe said, adding that “a significant tightening of policy to slow domestic demand” was also needed to reduce the current account deficit. “We can talk about personalities, track record, the signals and speculation about what [the new team] can do. But what’s really important is the timing and sequencing of policy measures . . . because there are so many moving parts in this adjustment,” Fitch’s Arispe said. More

The European Central Bank is likely to keep raising interest rates beyond its next policy meeting to tackle stubbornly high inflation, members of its rate-setting governing council said on Friday. Bundesbank president Joachim Nagel, one of the more hawkish ECB council members, said there was still “a long way to go” to reach the central bank’s inflation target of 2 per cent. That was even after rate-setters raised the benchmark deposit rate by a quarter-point to 3.5 per cent on Thursday, its highest level since 2001.“We may need to keep raising rates after the summer break,” Nagel said in a speech in Amsterdam. His comments went further than ECB president Christine Lagarde did in the press conference following Thursday’s decision, in which she only said rate-setters were “very likely” to raise rates again in July.Slovenian central bank boss Boštjan Vasle, another of the ECB’s more hawkish council members, also said a September rate rise was possible “if it turns out that inflation is more persistent than it seems at the moment”.While eurozone inflation has fallen from the 10.6 per cent peak in October to 6.1 per cent in May, it remains well above the central bank’s 2 per cent target. The ECB’s new quarterly forecasts, published on Thursday, show officials expect the headline rate of inflation and the closely watched core rate — excluding energy and food — to remain above 2 per cent until at least 2025. The core rate was 5.3 per cent in May. The hawkish projections led economists at several major banks — including Goldman Sachs, JPMorgan, UniCredit and BNP Paribas — to change their bets on how high eurozone rates will rise. They now expect two more interest rate increases, up from earlier expectations that the central bank would halt its tightening cycle in July.“The updated inflation projections point to a higher hurdle to finish the hiking cycle in July,” said Sven Jari Stehn, chief European economist at Goldman Sachs. Some economists said the ECB’s new growth forecasts were too optimistic — especially after the eurozone economy shrank in the past two quarters. The ECB said on Thursday it expected an expansion of 0.9 per cent in 2023, down from an early forecast of 1 per cent growth. Holger Schmieding, chief economist at German bank Berenberg, said: “If core inflation continues to recede slightly further in coming months, as we expect, and if the data on the real economy are more in line with our call for just 0.3 per cent growth in 2023, the ECB will probably stay put in September.”The IMF also warned of “persistently high” eurozone inflation on Friday and called for more rate rises, saying this would be needed over a “sustained period”. Eurozone member states should also rein in their budget deficits, the IMF said in a report on the bloc’s economy. More