The European Central Bank (ECB) raised interest rates by a record 75 basis points on Thursday while slashing its growth forecasts and lifting its inflation outlook, a reflection of Europe’s worsening energy crisis, which is likely to tip the bloc into recession before the year is out.
President Christine Lagarde warned that further rate hikes were now inevitable as the bank battled to stop “rampant inflation” becoming entrenched in the euro zone economy.
Following on from a 50 basis point hike in July and the recent surge in wholesale gas prices, the ECB raised its deposit rate to 0.75 per cent from zero while lifting its main refinancing rate to 1.25 per cent, their highest levels since 2011, with further moves anticipated in October and December.
The move will place further pressure on mortgage holders here and comes as homeowners are already coping with surging energy costs and rising prices generally. Headline inflation in the Irish economy moderated to 8.7 per cent in August but remained close to a four-decade high.
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“We expect to raise interest rates further, because inflation remains far too high and is likely to stay above our target for an extended period,” Ms Lagarde said, adding that Thursday’s decision was unanimous.
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“We think it will take several meetings,” she said. “How many is several? It’s probably more than two, including this one, but it’s probably also going to be less than five,” she said, suggesting that rate hikes could continue into early 2023.
Policymakers had for weeks oscillated between a 50 and a 75 basis-point increase, but another jump in both headline and underlying inflation likely settled the debate with Ms Lagarde repeatedly arguing that the current high level was simply unacceptable.
She also urged euro zone governments to tailor their energy support packages while admitting the bank had — up to now — got its forecasts wrong. She said most international institutions and economists also made forecasting errors because “it’s virtually impossible to actually anticipate and include in your models Covid, the war in Ukraine, the energy blackmail”.
The ECB’s new suite of forecasts painted a much dimmer picture.
The Central Bank now sees euro zone inflation averaging 8.1 per cent this year against a 6.8 per cent prediction in June, while the 2023 price growth estimate was raised to 5.5 per cent from 3.5 per cent. In 2024, the final year of its projection horizon, inflation is expected at 2.3 per cent, above its 2 per cent target.
Inflation could exceed these forecasts if the production capacity weakens; there are further hikes in energy and food prices; a rise in inflation expectations; or higher-than-anticipated wage rises, it said.
The impact of high energy prices will also weigh on growth, which is forecast to be 3.1 per cent this year against an expectation of 2.8 per cent in June. The ECB, however, slashed its 2023 expansion forecast to 0.9 per cent from 2.1 per cent.
With inflation running at a record high of 9.1 per cent across the bloc and Russia turning off the taps indefinitely on the biggest natural gas pipeline to Europe, the ECB’s move comes at a crucial juncture for the euro zone economy.
Most economists now expect the bloc to fall into recession in the coming months.
US Federal Reserve chairman Jerome Powell was participating in a discussion on US monetary policy on Thursday afternoon — overlapping with the ECB’s decision — with Fed officials soon due to enter into a blackout period before their next rake hike decision at the September 20th-21st meeting.
