The European Central Bank raised its key interest rates by an unprecedented 75 basis points on Thursday to fight inflation and signalled that further hikes are planned in October and December.
Following its July rate hike, the ECB raised its deposit rate to 0.75% from zero and lifted its main refinancing rate to 1.25%, their highest levels since 2011.
“The Governing Council decided to raise the three key ECB interest rates by 75 basis points,” said the ECB.
“Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 1.25%, 1.50% and 0.75% respectively, with effect from 14 September 2022.”
The ECB said its staff have significantly revised up their inflation projections and now expect inflation to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.
“The Governing Council took today’s decision, and expects to raise interest rates further, because inflation remains far too high and is likely to stay above target for an extended period,” said the ECB.
“According to Eurostat’s flash estimate, inflation reached 9.1% in August.
“Soaring energy and food prices, demand pressures in some sectors owing to the reopening of the economy, and supply bottlenecks are still driving up inflation.
“Price pressures have continued to strengthen and broaden across the economy and inflation may rise further in the near term.
“As the current drivers of inflation fade over time and the normalisation of monetary policy works its way through to the economy and price-setting, inflation will come down.
“Looking ahead, ECB staff have significantly revised up their inflation projections and inflation is now expected to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.
“After a rebound in the first half of 2022, recent data point to a substantial slowdown in euro area economic growth, with the economy expected to stagnate later in the year and in the first quarter of 2023.
“Very high energy prices are reducing the purchasing power of people’s incomes and, although supply bottlenecks are easing, they are still constraining economic activity.
“In addition, the adverse geopolitical situation, especially Russia’s unjustified aggression towards Ukraine, is weighing on the confidence of businesses and consumers.
“This outlook is reflected in the latest staff projections for economic growth, which have been revised down markedly for the remainder of the current year and throughout 2023.
“Staff now expect the economy to grow by 3.1% in 2022, 0.9% in 2023 and 1.9% in 2024.
“The lasting vulnerabilities caused by the pandemic still pose a risk to the smooth transmission of monetary policy.
“The Governing Council will therefore continue applying flexibility in reinvesting redemptions coming due in the pandemic emergency purchase programme portfolio, with a view to countering risks to the transmission mechanism related to the pandemic.”
Pietro Baffico, European Economist, Abrdn: “In line with expectations, the ECB decided to act forcefully with a 75bps hike for September, as the relentless rise of inflation keeps the central bank under pressure to frontload further its tightening cycle.
“The balance of the Governing Council has turned to hawkish views, retaining a meeting by meeting approach that does not exclude similar large hikes over for the rest of this year.
“While policymakers are aware of the risks of an economic slowdown, rising headline and core inflation – respectively at 9.1% and 4.3% – calls for decisive action to prevent de-anchoring inflation expectations. Economic growth has also been resilient so far this year; quarterly GDP growth was revised upward to 0.8% q/q in Q2 and labour markets remain strong, with a record low unemployment rate of 6.6%.
“The hawkish view is also underpinned by the new ECB macroeconomic projections, which acknowledge a lower growth and higher inflation outlook.
“Growth is foreseen to stagnate in the winter, albeit we think is more likely to enter recession, which the ECB only see it as a downside scenario.
“Crucially, the ECB projections expect inflation to remain above the 2% target throughout the horizon, moderating to 2.3% in 2024, making it more likely for the ECB to rise rates above the neutral rate. However,
“President Lagarde repeatedly avoided defining the level for the terminal rate, stressing the meeting by meeting approach and suggesting it should take “more than two meetings including this one but probably less than five.
“The ECB also removed until 2023 the 0% interest rate ceiling for remunerating government deposits, which will help to prevent an abrupt outflow of deposits into the market. But in any case, the tightening financial conditions will also raise borrowing costs for EU countries, fuelling concerns of fragmentation and recession risks. The risk for investors for a weaker EUR also remains. While an accelerated tightening would provide support for the currency, the stagflationary energy shock undermines it, and the depreciating trend could continue ahead of a looming recession.”
Victoria Scholar, Head of Investment, Interactive Investor: “The European Central Bank decided to raise three interest rates by 75 basis points in an unprecedented move that represents the largest hike in its history.
“The interest rate on the main refinancing operations, marginal lending facility and deposit facility will be increased to 1.25%, 1.5% and 0.75% respectively with effect from 14th September.
“In terms of its growth outlook, the ECB cut it 2023 GDP forecast to 0.9% and its 2024 forecast to 1.9%.
“However, these figures are still in positive territory, indicating that the central bank believes the euro area will fend off a recession. However it raised its inflation forecast for this year to 8.1% and next year to 5.5%.
“The ECB has been dealing with criticism that it is behind the curve, acting too slowly on inflation.
“A decade on from Draghi’s famous ‘whatever it takes’ speech, the ECB’s 75 basis point move sends a similar signal to the market that the central bank is indeed willing to go the extra mile to play catch up and bring inflation back down towards target.
“European stock markets are suffering in response to this hawkish shift from the ECB, with concerns about how the end of the era of cheap money will play out for business, which now will be forced to deal with higher borrowing costs and less flattering discounted cash flow analysis.
“Banks are the bright spot in today’s trade with this aggressive 75 basis point move potentially providing greater earnings potential on the back of higher net interest margins for the likes of Commerzbank and Deutsche Bank which are both rallying by more than 3%.
“Ahead of the announcement, currency markets were largely pricing in today’s hawkish hike, which is why the euro was little changed after the announcement.
“The common currency is trading around parity against the greenback, with safe-haven demand and interest rate differentials providing major tailwinds for the US dollar in recent months.”
Hinesh Patel, portfolio manager at Quilter Investors: “Having at long last joined the rate hike club in July with the first ECB interest rate rise for 11 years, it comes as little surprise that a further increase has been introduced today.
“A larger rate rise had already been penned in for September, and with the eurozone’s headline annual inflation rate rising to 9.1% last month, this was confirmed in the form of a 75 basis point hike with the promise of more to come.
“However, the ECB governing council’s decision to further increase rates is a sideshow to the increasing risks of sovereign debt sustainability. More important is the disappointing lack of news on measures to be deployed to reduce the risk of another sovereign debt crisis.
“At the margin, increasing policy rates will be a welcome boost for banks and savers who have been financially repressed, yet this cannot solve for the energy crisis exacerbated by Russia’s ongoing aggression on Ukraine.
“Ultimately, Lagarde’s council may be repeating the same mistake as Trichet’s in 2011 by hiking in to rising commodity prices that are outside of monetary policy control.”
Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown: ‘’Stuck between a rock and a hard place, ECB policymakers felt they had little option but to go ultra-big with the rate rise to try and cut the rope on inflation and spark a fall from its ascent.
“But it couldn’t come at a worse time with Russia’s gas taps to Europe turned off in retaliation for punitive economic sanctions. With energy prices so elevated, bringing an end to the price spiral is going to be far from easy, and the ECB is warning that fresh hikes will be on the way.
“Business and consumers will be faced with the double whammy of higher borrowing costs and worries about energy security, accelerating the prospects of recession and setting the scene for a bleak winter ahead.
“The latest fall in the US jobless claims numbers to a three-month low is likely to strengthen the mighty dollar even further, as it underlines the resilience in the American economy, and adds to expectations that the Fed will also step on the pedal of rate rises.
“This has piled further downwards pressure on the euro, which looks set to head back below parity with the dollar, raising fresh inflationary concerns as it’ll make imports that bit pricier.’’