Europe Announces First Interest Rate Hike In A Decade To Combat Inflation

The European Central Bank (ECB) today confirmed it will hike rates for the first time in over a decade in a sign that the era of loose policy and low inflation is coming to an end.

President Christine Lagarde and co said the central bank will lift rates 25 basis points next month, which will mark the first increase in the eurozone since 2011.

The central bank also hinted that it will move much faster if the inflation profile in the eurozone continues on its current upward trajectory.“If the medium-term inflation outlook persists or deteriorates, a larger increment will be appropriate at the September meeting,” the ECB said.

The ECB also said it will stop buying bonds on 1 July. 

The latest data shows prices rose 8.1 percent over the last year in the eurozone, the fastest acceleration since the creation of the euro in 1999.

Central banks tend to move in 25 basis point increments. 

However, this tradition was scrapped by the US Federal Reserve, which lifted borrowing costs 50 basis points at its last meeting as it scrambles to rein in policy to tame a 40-year high inflation rate.

In a sign of how concerned the ECB is about the inflation horizon, it raised its inflation projections again and now expects it to average 6.8 percent this year versus a previous forecast for 5.1 percent. 

The cost of living will average 3.5 percent in 2023 and 2.1 percent in 2024, marking four successive years of the ECB missing its two percent target.

The world’s biggest monetary authorities are in the process of turning off the ultra-stimulative policy that has characterized the global economy since the financial crisis and was ramped up during the Covid-19 crisis to tame the worst bout of inflation in a generation.

Higher interest rates tend to cool inflation by sucking demand out of an economy. Central banks have been accused of stoking inflation by leaving the money taps on for too long.

The likes of the ECB, Fed, and Bank of England are, however, walking a tight line between getting on top of inflation without dealing unnecessary long-term damage to their respective economies.

Price pressures are being driven by a combination of lingering Covid-19 restrictions hobbling trade flows, Russia’s invasion of Ukraine, and shallower labor pools.

The ECB, alongside the Fed and the Bank of England, has hoovered up government and corporate debt since the financial crisis and the Covid-19 crisis in a bid to stimulate demand and get inflation above historically low levels.

The ECB is still lagging behind the Fed and the Bank of England, both of whom have already started their rate hike cycles to tame inflation.

The Bank is expected to hoist rates for the fifth meeting in a row next Thursday, likely taking them to 1.25 percent.

The ECB, unlike the Bank and the Fed, will not sell bonds on its balance sheet and will continue to reinvest the proceeds from these assets.

By City AM

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