The European Central Bank intensified its battle against record inflation by hiking interest rates by a historic three-quarters of a percentage point and pledging “several” further increases, even as the outlook for economic growth darkens.
The unprecedented monetary-tightening step underlines growing alarm as price pressures in the 19-nation eurozone broaden beyond energy and the euro tumbles. The decision matched analyst expectations and brought the deposit rate to 0.75%.
The euro slid against the dollar, while money-market investors boosted bets on further monetary tightening after the announcement.
Accused of reacting too slowly to the upswing in inflation that began as Covid lockdowns ended and worsened when Russia invaded Ukraine, the aggressive move aligns the ECB more closely with the Federal Reserve, which is weighing a third straight hike of the same size this month.
“This major step front-loads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to the ECB’s 2% medium-term target,” officials in Frankfurt said in a statement. “Over the next several meetings the Governing Council expects to raise interest rates further.”
See also: ECB delivers landmark rate cut but few signals top
Addressing reporters after the announcement, President Christine Lagarde said policy makers reached their decision unanimously, and that the unprecedented tightening step wasn’t “the norm.”
“Determined action had to be taken,” she said. “For those who consistently repeat that the European Central Bank is lagging behind, I contend that we are on a journey that started back in December when we decided to put an end to asset purchases under PEPP. And now to continue on our normalization path with the front-loading exercise.”
The ECB raised its outlook for inflation this year and next, while slashing its forecast for economic expansion in 2023. The 0.9% projection for growth next year is still more optimistic than the 0.7% median of predictions collected by Bloomberg. Bloomberg Economics sees an advance of only 0.4%.
See also: ECB holds rates and signals cuts are still some way off
With the deposit rate above zero, the ECB also ended a system of so-called tiering that officials instituted in late 2019 to soften the effect on banks of negative monetary policy.
Thursday’s decision highlights how ECB hawks still have the initiative on the 25-member Governing Council, emboldened by another overshoot in inflation last month to 9.1% -- more than four times the goal.
Higher borrowing costs are unlikely to blunt the soaring energy prices behind that spike, with potentially worse to come after Russia halted natural gas supplies through a key pipeline. But the fear is that inflation expectations could spiral without aggressive hikes that will become ever-trickier to enact as Europe’s economy stumbles.
This week already saw political pushback as Spanish Prime Minister Pedro Sanchez warned that monetary tightening “must be made compatible with an economic-recovery path.” As the cost-of-living crisis saps demand, analysts foresee a euro-area recession starting this year, with some saying a downturn is under way now.
The prospects for Germany, the continent’s largest economy, are bleak due to its outsized reliance on the Kremlin for energy. While it has filled gas-storage facilities more rapidly than targeted, they’re not sufficient to exclude rationing during the winter.
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But even with Deutsche Bank AG Chief Executive Officer Christian Sewing warning that a recession is coming, Bundesbank President Joachim Nagel wants the battle with inflation to be prioritized over economic growth.
Higher rates may offer some support to the euro, whose slide below parity with the dollar has made imports, particularly of commodities, more expensive. In July, ECB officials “widely noted” that euro depreciation constituted an “important change” and “implied greater inflationary pressures,” according to an account of that meeting.
Lagarde reiterated that the ECB doesn’t target a specific exchange rate but said it’s “very attentive” to the situation around the currency.
Economists polled by Bloomberg reckon the ECB will raise the deposit rate until it reaches 1.5% -- broadly where analysts see the “neutral” interest rate that neither stimulates nor constrains the economy.
