ECB raises euro zone interest rates again by 0.25%
The European Central Bank raised interest rates for the 10th meeting in a row today to counter stubborn inflation but signalled that it is likely done tightening policy.
The ECB lifted its deposit rate to 4% from 3.75%, taking it to an all-time-high.
Markets and economists expect the policy tightening move to be the ECB’s last and now anticipate a lengthy pause, followed by rate cuts in the second half of next year.
Markets had seen unchanged rates as the most likely outcome of today’s meeting only days ago but expectations shifted towards a hike after a source close to the discussions said the ECB would raise its 2024 inflation projection in new forecasts.
“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 said in a statement.
Policymakers have been pulled in opposing directions by stubbornly high price growth figures and rising recession fears.
Inflation is still stuck above 5% and markets do not see it falling back to the ECB’s 2% target even in the longer term as an exceptionally tight labour market pushes up wages and high energy costs keep the pressure on prices.
But growth prospects are fading quickly, partly due to higher interest rates, and even services – long the bloc’s bright spot – have started to weaken, raising the risk the economy will slip into recession.
The ECB’s new economic projections reflect these shifts and could stoke fears of stagflation, where a period of economic stagnation is accompanied by high inflation.
Inflation is now seen at 3.2% next year after a 3% forecast three months ago while growth projections were cut to 0.7% for this year and 1% for 2024.
“Inflation continues to decline but is still expected to remain too high for too long,” the ECB added.
“The Governing Council is determined to ensure that inflation returns to its 2% medium-term target in a timely manner,” it added.
“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,” it said.
The gap between opposing camps in the Governing Council had appeared modest ahead of today’s meeting, with debate centred on whether the ECB had done enough or if one last rate hike was needed to get inflation down to target sometime in 2025.
The ECB’s decision to hike interest rates again was supported by a “solid majority” of governing council members, president Christine Lagarde said today, even though some members wanted to pause rates.
“Some governors would have preferred to pause,” Lagarde told reporters today after announcing the latest quarter-point hike.
ECB President Christine Lagarde
“But I can tell you that there was a solid majority of the governors to agree with the decision that we have made,” she added.
The ECB chief also said it was too soon to say whether interest rates had reached their peak.
“We can’t say that now we are at peak,” Lagarde told reporters.
While the ECB believes rates have reached levels that will make “a substantial contribution” to returning inflation to target, the bank’s next rate moves will be “data-dependent”, she said.
Supporters of a hike this week are likely to have argued it was needed because inflation, including underlying measures that strip out volatile components, remained too high, with a recent surge in energy prices threatening a new acceleration.
But the brisk tightening cycle – twice as steep as normally envisaged by the ECB’s own stress tests of the banking sector – has already left its mark on the euro zone economy.
With the manufacturing sector, which typically needs more capital to operate, already suffering as a result of higher borrowing costs, lending to companies and households has fallen off a cliff.
Services has now also started to struggle following a brief post-pandemic boom in tourism.
The euro zone’s biggest economy, Germany, was bearing the brunt of an industrial slump and heading for recession, according to several forecasts.
Once its rate increases end, the ECB is likely to begin a debate on mopping up more of the cash it pumped into the banking system through various bond-buying schemes over the last decade, although no decision on that matter was expected this week.
ECB interest rates after today’s increases
‘Unlikely to see further increases this year’
Reacting to today’s news, Joey Sheahan, Head of Credit at online brokers MyMortgages.ie said it is unlikely we will see any further increases this year.
“Hopefully, the next movement we see from the ECB will be downwards and maybe sometime next year,” Mr Sheahan said.
“The uncertainty of interest rate increases of 4.5% over the past 14 months has wreaked havoc with existing mortgage holders and house hunters alike,” he added.
Mr Sheahan said the latest ECB hike means that since July 2022, existing tracker mortgage holders have seen their repayments increase by €491 monthly or €5,892 annually, based on a €220,000 mortgage with 15 years remaining.
Brokers Ireland described today’s move by the ECB as very disappointing.
Rachel McGovern, Director of Financial Services at Brokers Ireland said she believes the ECB should have paused its rate stance until there is a better measure if the impact of the previous nine hikes.
“Experts tell us it takes 18 months and longer for the effects of rate increases to become apparent,” she said.
“This ECB policy is in our view going too far too fast and it is going to put a great deal more pressure on mortgage holders, on businesses and is also likely to negatively impact the wider economy, including housing.”