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The European Central Bank (ECB) raised its key interest rate to all-time record-high level on Thursday, September 14, and signalled this will likely be its final move in a more-than year-long fight against stubbornly high inflation.
The decision raises the ECB’s benchmark deposit rate to 4 per cent, up drastically from minus 0.5 per cent just a little more than a year ago and the highest since the euro was established in 1999.
The rate on the main refinancing operations now climbs to 4.50 per cent and on the marginal lending facility to 4.75 per cent. It marked the 10th straight increase since the central bank launched the most aggressive hiking cycle in its history in July last year after prices surged following Russia’s invasion of Ukraine.
The increase of a quarter-percentage point comes as central banks around the world, including the US Federal Reserve, try to gauge when to halt their swift series of rate rates before the economy tips into a downturn and people lose their jobs.
Economists and investors struggled to anticipate the result, ever since a speech by President Christine Lagarde last month that overtly avoided any signal of her intentions for the decision. Ahead of the meeting, analysts were sharply divided over whether the ECB would lift rates again or finally take a pause due to mounting signs of the economic strain on the 20 countries that use the euro.
Against this backdrop, the ECB sent a clear message it was probably done raising rates. “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target,” said the ECB in a statement.
“Future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary,” President Christine Lagarde said, adding that policymakers will keep relying on available data. However, she added that “we can’t say that now, that we are at peak.”
ECB cuts growth forecast, raises inflation outlook
The SCB has cut its growth forecasts for the eurozone over the next three years, as tougher financing conditions are expected to dampen domestic demand at a time when international trade is also weakening.
The euro area’s economy is now expected to expand by 0.7 per cent this year, 1.0 per cent in 2024 and 1.5 per cent in 2025. The eurozone economy has been teetering on the edge of recession since last year, growing only 0.1 per cent in each of the first two quarters of this year. The new economic projections stokes fears of stagflation, where a period of economic stagnation is accompanied by high inflation.
The ECB also said that the eurozone inflation was expected “to remain too high for too long” as it raised its inflation forecast for this and next year but lowered it for 2025. The ECB sees inflation reaching 5.6 per cent in 2023, 3.2 per cent in 2024 before easing to 2.1 per cent in 2025.
The annual inflation of 5.3 per cent in the 20 countries that use the euro currency is well above the bank’s target of 2 per cent, troubling consumers over purchasing power and contributing to economic stagnation — supporting arguments for the rate increase.
What’s weighing on Eurozone’s growth outlook?
The major European economies — Germany, France, Spain and Italy — also saw shrinking activity in August in the services sector even at the tail end of a strong tourism summer in Spain and Italy, according to S&P Global’s surveys of purchasing managers. Services is a broad category that includes hotel stays, haircuts, car repairs and medical treatment.
That comes on top of a slowdown in global manufacturing that is hitting Germany, Europe’s biggest economy, particularly hard. The eurozone economy has been teetering on the edge of recession since last year, growing only 0.1 per cent in each of the first two quarters of this year.
The economic picture in Europe does not resemble a typical recession because unemployment is at a record low of 6.4 per cent. Labor shortages have sent people’s pay higher — one factor complicating the ECB’s inflation fight.
Also weighing on the outlook is a weaker euro against the strengthening US dollar as investors take the view that economic weakness will hit Europe and China. They are betting that the US Federal Reserve might manage a “soft landing” by finishing its rate hikes without pushing the economy into a downturn.
Interest rates combat inflation by raising the cost of credit for things people want to buy, particularly houses, and for business investment in buildings and equipment. It cools off demand for goods and relieves upward pressure on prices. However, the downside is that rate hikes can hurt economic growth if they’re overdone.
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