Description:- The ECB said it will end bond buys on July 1 then raise interest rates by 25 basis points later that month. It will hike again in September and may opt for a bigger move then if inflation continues to surprise.

The European Central Bank brought down the curtain on years of ultra-loose monetary policy yesterday and signaled a series of rate hikes that may be scaled up from September if the inflation outlook fails to improve. With inflation at a record-high 8.1% and still rising, the ECB now fears that price growth is broadening out and could morph into a hard-to-break wage-price spiral, ending a decade of anemic price growth and heralding a new era of higher prices.

The ECB said it will end bond buys on July 1 and then raise interest rates by 25 basis points later that month. It will hike again in September and may opt for a bigger move then if inflation continues to surprise.

The rapid rise in inflation was driven initially by energy prices but food and services costs are now also rising. The size of rate hikes to curb price growth has been intensely debated by ECB policymakers, with Chief Economist Philip Lane preferring 25-basis-point moves in July and September but others arguing for 50 bps to be considered.

Supporting their case, the ECB raised its inflation projections once again, now expecting inflation at 6.8% this year versus a previous forecast for 5.1%. In 2023, it sees inflation at 3.5% and in 2024 at 2.1%, indicating four straight years of inflation overshoots. “High inflation is a major challenge for all of us. The Governing Council will make sure that inflation returns to its 2% target over the medium term,” the ECB said.

All this leaves ECB President Christine Lagarde, who just months ago said that a rate hike this year was highly unlikely, in a tricky position at her Thursday news conference.

If she pushes back strongly, the ECB president might signal a commitment that could become obsolete within weeks, much like the no rate increase pledge. But if she ignores markets, even more, aggressive tightening might be priced in, pushing up borrowing costs unnecessarily.

The ECB’s first rate hike in over a decade will still leave it trailing most of its global peers, including the U.S. Federal Reserve and the Bank of England, which have been raising aggressively and promising even more action.

While the start of policy tightening is now set, the end point remains uncertain.

Lagarde has said that rates should move towards the neutral point at which the ECB is neither simulating nor holding back growth. But this level is undefined and unobservable, leaving investors guessing just how far the ECB wants to go.

Another question is how the ECB will handle the divergence in borrowing costs of various member states, an issue the ECB said it may address but did not mention in Thursday’s policy statement.