The European Central Bank (ECB) raised its basic interest rates on Thursday by an unprecedented amount of 75 basis points and pointed to further increases, prioritizing the fight against inflation, despite the fact that the bloc’s economy is headed for a likely winter recession.
With inflation running at its highest level in half a century and approaching double digits, ECB leaders are concerned that rapid price growth could take hold, eroding the value of household savings and unleashing a spiral of prices and wages that is difficult to break.
Following the July rate hike, the ECB raised its deposit rate from zero to 0.75% and raised its main refinancing rate to 1.25%, its highest levels since 2011, with further increases expected in October and December.
“This important step advances the transition from the current highly flexible level of interest rates to levels that guarantee the timely return of inflation to the ECB’s medium-term target of 2%,” the central body said in a statement.
Monetary policymakers had wavered for weeks between a 50 and 75 basis point hike, but a new jump in headline and core inflation appears to have settled the debate as figures indicate price growth is filtering through. throughout the economy, which makes its eradication even more difficult.
In fact, the ECB has increased its inflation forecasts again, raising the outlook for 2023 from 3.5% to 5.5% and placing the 2024 rate at 2.3%, above its 2% target.
Markets were little surprised, however, as investors had already estimated the probability of a 75 basis point move at more than 80%, though economists polled by Reuters were more divided, showing only a slim majority expecting a move. major movement.
Despite the strong increase, further rate hikes are likely, according to the ECB.
“In the next meetings, the Governing Council plans to raise interest rates further to curb demand and protect itself from the risk of a persistent upward shift in inflation expectations,” the ECB added.
Ahead of the meeting, conservatives at the ECB feared that anything short of a sharp rate hike would indicate the ECB was not serious about its inflation-fighting mandate, which is officially its only goal.
There is a risk that already high long-term inflation expectations could rise, leading to a loss of confidence in the ECB and raising questions about the bank’s inflation targeting framework.
A timid intervention could also weaken the euro and further boost inflation by making energy imports more expensive.
The euro has been languishing around parity with the dollar for weeks, not far from the two-decade low hit earlier this month.
This means that exports of all kinds of products, from oil to cars, are more expensive, which increases prices for the consumer.
Those responsible for the organization have also defended the need to bring forward the rate hikes, in part to send a strong signal about the central bank’s commitment to fighting inflation and, in part, to carry out most of the increases before the start of the recession is evident.
With high energy prices sapping purchasing power, a recession is virtually inevitable. However, monetary policy is largely powerless in the face of a supply shock-induced slowdown, reinforcing the case for hikes even if the economy suffers.
Some bank officials are now talking openly of a recession and the ECB’s new projections also show much lower growth in the coming years.
Still, some ECB leaders might even welcome a shallow recession that — given the current shortage of available labor — could provide relief to companies now struggling to find workers.
The bank sees the euro zone economy growing 3.1% this year and 0.9% in 2023. While the growth forecast for this year was raised slightly, it was sharply lowered for 2023.