ECB raises key rates by 75 basis points to tame inflation
14 Sep 2022
The European Central Bank (ECB) on Thursday announced a 75 basis point increase in its three official interest rates, its biggest ever single move in interest rates, and warned of more hikes, as it struggles to bring record high inflation under control.
Accordingly, ECB’s key deposit rate, which provides the effective floor for money-market rates, will go up to 0.75 per cent, the refinancing rate to 1.25 per cent and the overnight lending rate to 1.50 per cent, with immediate effect.
“This major step frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to our two per cent medium-term target. Based on our current assessment, over the next several meetings we expect to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations, Christine Lagarde, president of the Frankfurt-based central bank, said in her policy announcement.
ECB’s move, which is at the top end of market expectations, comes amidst warings, including by the bank's own chief economist Philip Lane, that the Eurozone economy is facing an ever more likely recession due to the war in Ukraine and, to a lesser extent, the knock-on effects of pandemic-era stimulus.
All three rates still remain well below the current rate of inflation, which hit a new euro-era record of 9.1 per cent in August.
The euro, the European common currency, fell around half a cent following the ECB announcement. Eurozone government bond yields rose as markets adjusted their medium-term forecast. However, benchmark 10-year yields rose largely in parallel with each other, avoiding the kind of spread-widening that signals increased stress in Eurozone financial markets.
The bank, however, raised its own forecasts for the next couple of years, and now sees inflation at 8.1 per cent on average this year, up from 6.8 per cent forecast in June. It also revised down its estimates for economic growth over the next two years, despite nudging up its forecast for the current year to 3.1 per cent from 2.8 per cent three months ago.
The ECB now expects the Eurozone economy to grow only 0.9 per cent in 2023 before accelerating again to 1.9 per cent as it returns to its pre-pandemic trend level. However, Lagarde said the bank doesn't expect a recession, saying only that the economy will stagnate in the next six months.
Separately, the bank also ended a hangover from the period of negative interest rates. It said it will revert to paying banks a uniform rate on their reserves, which are largely parked in the deposit facility. It had previously allowed a portion of them to be remunerated at a higher level, reducing the penalty effect for holding excess liquidity.