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Lagarde: ECB will ‘stay the course’ on rate hikes

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Christine Lagarde warned financial markets on Thursday that the European Central Bank was determined to “stay the course”. She has signaled that the central bank has further aggressive rate hikes to keep inflation down.

The euro was boosted by comments from the ECB president at the World Economic Forum in Davos. Markets should abandon their belief that the ECB will soon slow down its pace of rate hikes in the face of signs that inflation in the euro zone has peaked, she said.

“I would invite (financial markets) to correct their position; that would be sensible,” she told a panel of experts.

Immediately after Lagarde’s hawkish comments, the euro rose 0.2% against the dollar to trade at $1.0821. Borrowing costs for euro zone member governments also rose.

Rate-setters on the ECB’s governing council next meet on Feb. 2, when they are expected to raise the benchmark deposit rate by 50 basis points to 2.5 percent. Lagarde’s comments boosted the odds of a further 50 basis point hike when the governing council meets in March.

Silvia Dall’Angelo, senior economist at investment management firm Federated Hermes, said: “In the short term, the ECB’s path is set and rates will rise further in the coming months.”

The European Central Bank raised interest rates by a cumulative 2.5 percentage points last year to counter price surges; euro zone inflation hit a record high of 10.6 percent in October last year. However, euro zone rates remain below the cost of borrowing in the US and UK.

Markets are increasingly betting that U.S. interest rates are approaching their peak, with the Federal Reserve set to scale back rate hikes from 0.5 percentage point to 0.25 percentage point in the coming months. Such expectations of fewer rate hikes in the U.S. have led to speculation that rate setters elsewhere may follow suit.

However, Krishna Guha of research firm Evercore ISI said the ECB was “much earlier in the current tightening cycle” than the Fed, with its “default path” between February and March A 0.5 percentage point rate hike will continue at the July meeting.

Lagarde added that headline inflation, core inflation and all other measures of inflation still worry the Frankfurt-based ECB. “By all accounts, inflation is too high,” she said.

Headline inflation has eased in recent months, but core inflation — which strips out changes in food and energy prices and is seen as a better gauge of underlying price pressures — rose to 5.2% in the year to December , up from 5 percent in November.

“It will take several months for core inflation to fall back to a level that makes the ECB more comfortable,” said Frederik Ducrozet, an economist at Pictet Wealth Management. “Nearly all ECB officials, whether dovish or hawkish, appear to be united in their fight against inflation.”

Lagarde said interest rates would need to remain in a “restrictive range” for long enough to ensure inflation fell back to the ECB’s 2 percent target “in a timely manner”.

Lagarde’s comments came as Italian government bonds sold off on Thursday, with the country’s 10-year yield rising 0.09 percentage point to 3.83%. Bond yields move inversely with prices and tend to rise on expectations of rate hikes.

Later, the sell-off extended to the debt of other euro zone members: the yield on two-year German government bonds rose 0.06 percentage point to 2.51% by midday.

The stock market fell. The pan-European Stoxx Europe 600 index fell 1.3%, with all sectors in negative territory. Germany’s Dax and France’s CAC 40 both fell 1.4%.

Lagarde also said a resilient job market in the euro zone could lead to higher wages.

“The job market in Europe has never been more dynamic,” she said. “Unemployment numbers are at rock bottom compared to what has been the case over the past 20 years. The equally important labor force participation rate is also at very high levels, and it’s pretty much the same across the euro area.”

The head of the European Central Bank said she was relieved by signs of improvement in the euro zone economy. “The news over the past few weeks has been much more positive,” she said. “2023 will not be a great year, but it will be much better than previously feared.”

Translator/Japanese style

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