European Central Bank to Raise Rates for the First Time in Eleven Years

The European Central Bank (ECB) said today that the central bank for the eurozone region would raise reference interest rates by 25 basis points in July and signaled that there could be bigger rate hikes in the second half of the year. This is the first-rate hike that the ECB has undertaken since 2011. After a prolonged period of zero to even negative interest rates, stemming from a slow recovery from the 2008 global financial crisis, the Greece debt crisis, Brexit, and general economic malaise, rising inflation has forced the bank to act.

While the ECB kept rates unchanged in today’s meeting, the official statement read that “if the medium-term inflation outlook persists or deteriorates, a larger increment will be appropriate at the September meeting.” In its’ base case scenario, the Governing Council of the central bank believes that a sustained path of future hikes in rates would be appropriate. The current inflation reading in the 19 countries that use the Euro hit an all-time high of 8.1% in May.

The bank’s rate hike in July would bring the deposit rate up to -0.25% from the current -0.5%, and potentially +0.25% by the end of September, if it does elect to go with a 50 basis points hike in that meeting. The official deposit rate in the eurozone has been negative for over eight years at present. ECB President Christine Lagarde also noted that the strategy of the bank will be to start with slow and gradual rate hikes, before increasing the pace later if inflation cannot be tamed.

The ECB also said that “high inflation is a major challenge for all of us. The Governing Council will make sure that inflation returns to its 2% target over the medium term.” This is a relative shift in the ECB’s policy over the past 6 months. While it had been one of the most reluctant central banks to raise rates, sustained elevated inflation readings and a prolonged war in Ukraine have convinced the bank that it needs to act soon, or inflation could spiral out of control.

In addition to raising rates, the ECB also trimmed its growth outlook for the region. While the bank expected the zones economy to grow at a 3.7% pace for 2022 in its’ March projections, the current outlook calls for growth of just 2.8%. For 2023, growth forecasts have been trimmed from 2.8% to 2.1%. The view on economic growth may receive further cuts in subsequent meetings, especially if the war in Ukraine leads to an embargo on Russian natural gas.

Even as price pressures persist, there are small signs that inflation may be peaking soon. Specific price indicators, especially for semiconductors, agricultural commodities, and finished goods from China, are starting to turn back down. However, there is a real fear now that both the U.S. and Europe could slip into mild recessions later in 2022. To allay some of the fears, Lagarde reiterated the ECB’s preparedness to deal with any market-place panic and fallout from the hike in rates.

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