Unprecedented European Central Bank Rate Hike Sets New Records

President of the European Central Bank (ECB) Christine Lagarde gestures as she addresses a press conference following the meeting of the governing council of the ECB in Frankfurt am Main, western Germany, on July 27, 2023.

Daniel Roland | Afp | Getty Images

The European Central Bank (ECB) announced its 10th consecutive hike in its main interest rate on Thursday, prioritizing the fight against inflation over a weakened economy.

With this rate rise, the central bank’s main deposit facility has increased from -0.5% in June 2022 to a record 4%. The decision to hike rates is supported by upward revisions in newly published staff macroeconomic projections for the euro area, which now forecast inflation to average at 5.6% this year and 3.2% next year.

However, the ECB slightly lowered its medium-term forecast from 2.2% to 2.1%.

In a market-moving statement, the ECB indicated that further rate hikes may not occur at the moment.

“Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target,” the ECB stated.

“The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary.”

The euro fell sharply in response to the announcement, trading at a three-month low against the U.S. dollar at $1.0686 at 3 p.m. Frankfurt time.

On the other hand, European stocks rallied, with the Stoxx 600 index rising by 1.1%.

As part of the rate hike, the ECB also increased the interest rates on its main refinancing operations and marginal lending facility by 25 basis points to 4.5% and 4.75%, respectively.

The ECB also reduced its economic growth projections for the euro area, with expected expansion rates of 0.7% in 2023, 1% in 2024, and 1.5% in 2025.

There was divided speculation among economists and analysts about the outcome of this September’s meeting, with some anticipating a rate hike and others wanting to wait for more certainty.

Inflation fears have been fueled by reports of tighter oil supply, higher prices, and wage growth. A Reuters article released on Wednesday, prior to the ECB’s projection announcement, stated that the ECB expects euro zone inflation to remain above 3% in 2024, further increasing expectations of a rate hike.

“Some [Governing Council] members did not draw the same conclusion, and some governors would have preferred to pause and reserve future decisions once more certainty, more intelligence, would have resulted from the passing of time and the impact of our many previous decisions,” commented ECB President Christine Lagarde.

Lagarde mentioned that the Governing Council remains dependent on data for future decisions and emphasized that rates at current levels would contribute significantly to the fight against inflation.

Germany slump

Consumer price inflation in the euro area was 5.3% in August, the same level as core inflation (which excludes food and energy costs).

Germany, the largest economy in Europe, has been experiencing a continued decline in business sentiment and a decline in both services and manufacturing.

Predictions show that Germany is the only major European economy expected to contract this year. The wider picture is also pessimistic, as euro zone business activity reached its lowest level since November 2020 in August.

Peter Schaffrik, Chief European Macro Strategist at RBC Capital Markets, highlighted that market attention will not be solely on the rate hike, but also on the language used by the ECB in its statement.

Schaffrik mentioned that focus will be on the 2025 inflation forecast, which was revised lower. Additionally, the descriptor of rates being maintained for a “sufficiently long duration” will indicate a flat path forward for quite some time.

Reference

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