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Market Extra: Here’s what to watch as the ECB readies its first rate hike in more than a decade

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With inflation at a record high of 8.6% in the eurozone, the European Central Bank is set to make its first interest-rate hike since 2011 on Thursday.

But the question is, by how much. A report from Reuters, citing unnamed sources, this week said there were internal deliberations that the ECB may lift rates by 50 basis points, or half a percentage point, rather than the 25 basis-point rise that the central bank last month said it would deliver at its July meeting. That report lifted the euro
EURUSD,
+0.29%

and German bund yields
TMBMKDE-02Y,
0.632%
.

That has echoes of The Wall Street Journal report on the eve of the Fed’s decision in June to lift rates by three-quarters of a point rather than a half-point.

The ECB decision also will be momentous for the introduction of a new anti-fragmentation tool designed to limit the spreads between bond yields in the eurozone.

Here’s what leading ECB watchers are looking for on Thursday when the central bank announces its rate decision, at a new time of 2:15 p.m. Central European time (8:15 a.m. Eastern), and President Christine Lagarde starts her press conference a half-hour later.

Economists at Citi said it would be risky for the central bank to hike by a half point. “We see a number of reasons why many governors may be tempted by a larger (50 bps) hike. Should they choose to do so, without obvious warning or cause, we fear it may cast a shadow on any other commitment, including that of countering fragmentation,” they said.

Economists at Berenberg Bank agree the ECB will lift rates by a quarter-point on Thursday, and then expect a half-point rate hike in September and another quarter-point rise in December.

Fawad Razaqzada, financial markets index at City Index, said Lagarde gave herself wiggle room to deliver a more aggressive hike. Before the latest inflation data was released, Lagarde had said there would be conditions “in which gradualism would not be appropriate,” adding those would be if higher inflation threatens to de-anchor inflation expectations or if there were signs of a more permanent loss of economic potential. “Well, given that inflation has surged to a new record high in the Eurozone, it looks like a more forceful ECB might be needed,” said Razaqzada.

Economists at Investec say the ECB has a difficult tight rope to walk with respect to the anti-fragmentation tool. The existing OMT program, for instance, requires countries to take one of the bailout program’s on offer, which no country at the moment would be willing to accept.

“As such we suspect the new tool to water down conditionality to the bare minimum, perhaps even similar to that of the Securities Market Programme which did not tie purchases to any conditions. The ECB will need to calibrate its announcement on this carefully, the hope being that markets receive it positively enough that it never needs to be used. However if it falls short, spreads will likely widen further,” they said in a note to clients.

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