AMSTERDAM (AFP) – The European Central Bank (ECB) yesterday said it would raise interest rates for the first time in over a decade next month to combat runaway inflation, bringing the curtain down on the eurozone’s era of cheap money.
ECB governors, exceptionally meeting in Amsterdam instead of Frankfurt, provided markets with an unexpectedly precise statement setting out their path to monetary policy normalisation after years of ultra-low rates and easy credit.
As a first step, the ECB said it would end its massive bond-buying stimulus as of July 1.
The bank’s governing council then plans “to raise the key ECB interest rates by 25 basis points” at its next meeting on July 21, the ECB said in a statement.
It will raise rates again in September, with the size dependent on the economic outlook. The last time the ECB hiked rates was in 2011.
“The ECB officially ends its long era of unconventional monetary policy,” said ING bank economist Carsten Brzeski. Pressure had been growing on the ECB to take tough action after other major central banks like the United States (US) Federal Reserve and the Bank of England already moved to rein in prices with aggressive rate hikes.
Inflation in the 19-nation euro area rose to a record 8.1 per cent in May, well above the ECB’s two-percent target. The surge has largely been driven by the war in Ukraine, which has pushed up the cost of energy, food and raw materials around the globe. The ECB lowered its eurozone economic growth forecast while raising its projections for inflation.
“High inflation is a major challenge for all of us,” the ECB said in a statement.
Attention now shifts to ECB chief Christine Lagarde’s afternoon press conference, where she will be grilled about the ECB’s next moves.
The biggest challenge facing Lagarde right now is finding the right balance between raising borrowing costs to cool inflation, without jeopardising the eurozone’s already stuttering economy.
Underscoring those worries, the ECB slashed its growth outlook for the 19-nation club to 2.8 per cent in 2022 and 2.1 per cent in 2023, from 3.7 and 2.8 per cent previously.
The war in Ukraine “is disrupting trade, is leading to shortages of materials, and is contributing to high energy and commodity prices”, it said, adding that “these factors will continue to weigh on confidence and dampen growth, especially in the near term”.
The July 1 end of its bond-buying scheme will draw a line under the last in a series of debt-purchasing measures worth a total of around EUR5 trillion since 2014.
Scrapping the scheme paves the way for what Lagarde has called a “lift off” in rates. Of the ECB’s three main rates, the so-called deposit rate currently stands at minus 0.5 per cent – meaning lenders pay to park excess cash at the bank.
Lagarde has said the ECB aims to exit eight years of negative rates by the end of September. “Today’s decision shows it’s managed to find a compromise between the doves and the hawks,” Brzeski said.
“A 50 basis point rate hike in July seemed to be fended off by opening the door for 50 basis points in September.”
The size of September’s hike will depend to a large extent on how the outlook for the economy changes.
Despite unveiling a downgraded forecast for economic growth yesterday, the ECB expressed optimism over the longer term outlook.
“Once current headwinds abate, economic activity is expected to pick up again,” it said.
“The conditions are in place for the economy to continue to grow on account of the ongoing reopening of the economy, a strong labour market, fiscal support and savings built up during the pandemic.”
On inflation, the ECB said it expected consumer prices to soar to 6.8 per cent in 2022, up from 5.1 per cent in its previous forecast.
Inflation is seen easing to 3.5 per cent in 2023 and 2.1 per cent in 2024 – both also higher than earlier estimates.
“These projections indicate that inflation will remain undesirably elevated for some time,” it said.