ECB may keep raising rates beyond 2pc level

The European Central Bank (ECB) will probably continue to raise interest rates beyond 2%, but "jumbo" rate hikes will not become a new habit, France's central bank chief said in a speech in Tokyo on Tuesday.

The ECB has increased rates at its fastest pace on record recently, hiking them by a combined 200 basis points to 1.5% in just three months.

Despite that rapid pace, markets still expect the bank to hike rates further to tame sharp, broad-based inflation. "We are clearly approaching what I would call the 'normalisation range' which can be estimated at around 2%.

We should reach this level by December," French central bank Governor Francois Villeroy de Galhau said in a speech at a business conference in the Japanese capital.

"Beyond this level, we will probably continue to raise rates, but we may do so in a more flexible and possibly less rapid manner.

Jumbo rate hikes will not become a new habit." Signs of peaking headline and core inflation in the United States were "good news" for everyone, he said, given that the world's top economy had been at the forefront of the global inflation cycle.

Data released last week showed US consumer prices rose less than expected in October, bringing the annual increase below 8% for the first time in eight months.

"US monetary tightening has had strong spillovers on the rest of the world through the high level of the dollar," the central banker said.

Earlier, the European Central Bank has aggressively raised interest rates to try and bring rising prices under control, as eurozone inflation soared towards 10 percent.

Until recently, inflation was for years persistently low in the eurozone. From the 2008 financial crisis through the coronavirus pandemic in 2020, the ECB stepped in with exceptional measures to prop up the economy.

The policy of quantitative easing initiated in 2015 and the pandemic emergency purchase programme - or "PEPP" - involved the wholesale purchase of government and private debt on the secondary market.

The aim of the two bond-buying programmes was to further suppress interest rates in order to pump up the economy and boost prices. The Frankfurt-based central bank also unleashed several waves of massive and inexpensive loans to banks, known as TLTROs.

The ECB hoovered up five trillion euros ($4.9 trillion) in debt over the past 10 years and has a stock of around two trillion TLTRO loans in its portfolio, bringing its total balance sheet to around 8.8 trillion euros.

The longer the ECB continues to roll over the debt on its balance sheet by purchasing new assets, the longer it keeps the expansionary monetary policy of the last 10 years going.

Increasingly, the sheer scale of the programme seems out of keeping with the ECB's aggressive moves to raise interest rates in the face of runaway inflation.

The ECB is therefore thinking more concretely about winding down its balance sheet to completely turn the page on the era of ultra-loose monetary policy.

This so-called quantitative tightening would represent the next step in the "normalisation" of the ECB's policy and "underscore our commitment to ensuring that inflation returns to the (ECB's) medium-term target of two percent (inflation)", according to German central bank president Joachim Nagel.

A first step could be to begin by shedding the assets built up under the original quantitative easing programme between 2015 and 2021.

The ECB has meanwhile committed itself to maintaining the stock of PEPP assets until the end of 2024.

With a large part of the TLTRO loans set to be paid back by the end of 2023, the ECB could also incentivise banks to pay them back sooner rather than later as the scheme looks more and more like a subsidy for financial institutions.