The European Central Bank raised its interest rates by a massive 75 basis points, the biggest hike ever in the single currency bloc’s history, and signaled more tightening in the coming months as policymakers try to rein in runaway inflation in a bid to support a slowing economy.
“This major step frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will support a timely return of inflation to our two percent medium-term target,” ECB President Christine Lagarde said Thursday.
In the previous meetings, Lagarde had signaled at least a 50 basis point hike in September. However, inflation has been setting new records in the euro area and its member countries in recent months, thus raised the pressure on rate-setters to do more.
Runaway inflation has seen central banks across the world resort to aggressive tightening of monetary policy. The ECB’s peer, the US Federal Reserve, has led the charge against ultra-high inflation that is mainly driven by higher energy prices.
The Governing Council, led by Lagarde, raised the main refinancing rate to 1.25 percent, the deposit facility rate to 0.75 percent and the marginal lending rate to 1.50 percent.
The move was in line with economists’ expectations that were fueled by the recent hawkish rhetoric from some ECB policymakers favoring forceful action against high inflation.
“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,” Lagarde said during the post-decision press conference.
She also said future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach.
Eurozone inflation hit a record 9.1 percent in August on the back soaring food and energy prices.
The bank assessed that inflation remains far too high and is likely to stay above its 2 percent target for an extended period.
The latest ECB Staff projections unveiled on Thursday showed a marked upgrade to the Eurozone inflation outlook.
Inflation is now forecast to average 8.1 percent this year, 5.5 percent next year and 2.3 percent in 2024.
Lagarde pointed out that the depreciation of the euro has also added to the build-up of inflationary pressures.
Policymakers also assessed that very high energy prices are reducing the people’s purchasing power and, supply bottlenecks and adverse geopolitical situation continue to constrain economic activity.
The euro area growth forecasts were lowered sharply. The ECB Staff now expects the economy to grow by 3.1 percent this year, 0.9 percent next year and 1.9 percent in 2024.
The bank expects the slowing economy to lead to some increase in the unemployment rate in the coming months.
The risks to growth are primarily on the downside, while those to the inflation outlook are mainly on the upside, Lagarde said.
“We still think the European Central Bank is too optimistic about growth but have changed our call; we now expect it to hike rates by another 75bp before the end of the year,” ING economist Carsten Brzeski said.
Lagarde said the lasting vulnerabilities caused by the pandemic still pose a risk to the smooth transmission of monetary policy and hence the bank will continue to apply flexibility in reinvesting redemptions coming due in the pandemic emergency purchase program portfolio to counter these risks.
The bank also decided to suspend the two-tier system for remuneration of excess reserves by setting the multiplier to zero, as the deposit rate has been raised to above zero.
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