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Business

The European Central Bank has the largest interest rate increase ever




FRANKFURT, Germany (AP) – The European Central Bank made its biggest rate hike ever on Thursday, after the U.S. Federal Reserve and other central banks in a global storm of rapid rate hikes meant to stem inflation that is squeezing consumers and pushing Europe into recession.

The bank’s governing council raised its main benchmarks by an unprecedented three-quarters of a percentage point for the 19 countries that use the euro currency. The ECB usually moves interest rates by a quarter point and had not raised its central bank lending rate by three quarters since the euro̵[ads1]7;s launch in 1999.

Bank President Christine Lagarde said the ECB would continue to raise interest rates “over the next few meetings” because “inflation remains far too high and is likely to remain above our target for an extended period”.

Lagarde stopped short of predicting a recessionalthough many economists predict one at the end of the year and beginning of 2023 as high energy and food prices undermine people’s purchasing power. The bank’s assumption is that economic output will not fall outright but “stagnate” later this year and early next, she said.

The bank’s jumbo hike is aimed at increasing borrowing costs for consumers, governments and businesses, which in theory slows spending and investment and cools soaring consumer prices by reducing demand for goods.

Analysts say it is also aimed at bolstering the bank’s credibility after it underestimated how long and how severe this burst of inflation would be. After hitting a record 9.1% in Augustinflation may rise to double digits in the coming months, say economists.

The war in Ukraine has fueled inflation in Europe, with Russia sharply reducing the supply of cheap natural gas used to heat homes, generate electricity and run factories. It has driven up gas prices by 10 times or more.

European officials reject the cuts as blackmail with the aim of pressuring and dividing the EU over support for Ukraine. Russia has blamed technical problems and this week threatened to cut energy supplies completely if the West introduces planned price caps on Moscow’s natural gas and oil.

The ECB has lagged behind other central banks when it comes to raising interest rates. Central banks around the world have been struggling after being wrong-footed by inflation fueled by the war in Ukraine and the lingering effects of the COVID-19 pandemic, which has sent energy prices higher and constrained the supply of parts and raw materials.

The sudden campaign to raise interest rates follows years in which borrowing costs and inflation remained low due to broad trends such as globalisation, an aging population and digitalisation.

Rejecting comparisons, Lagarde said “we are not trying to imitate any other central bank” and pointed out that the ECB began tightening monetary policy in December, when it decided to phase out its pandemic stimulus through bond purchases.

Some economists say the ECB’s interest rate hikes, including a half-point hike at its last meeting in Julycould deepen a European recession predicted for the end of this year and the beginning of 2023, caused by higher inflation that has made everything from groceries to utility bills more expensive.

Lagarde said a recession in 2022-23 would only occur under a “really dark” worst-case scenario where all Russian natural gas is cut, alternative supplies are not available and governments have to resort to energy rationing.

She praised the efforts of the EU’s executive commission to limit energy pricesfor example, through regulation of the electricity market, noting that while interest rate increases send “a strong signal” about the bank’s commitment to fighting inflation, “I cannot reduce the price of energy.”

But the bank has reasoned that interest rate increases will prevent higher prices being baked into the expectations of wage and price agreements, and that decisive action now will prevent the need for even greater increases if inflation takes hold.

The European Central Bank “wants to fight inflation – and wants to be seen as fighting inflation,” said Holger Schmieding, chief economist at Berenberg bank.

However, energy prices and government support programs to protect consumers from some of the pain “will have a much greater impact on inflation and the depth of the looming recession than monetary policy,” he said.

Interest rate rises often support the exchange rate – but the euro has been under pressure due to more general fears of recession and economic growth. It has recently fallen below $1, the lowest level in 20 years. The euro fell around half a cent after the ECB decision, to around 99.5 US cents.

The ECB’s benchmark index is now 1.25% for lending to banks. The Fed’s main benchmark is 2.25% to 2.5% after several big rate hikes, including two of three-quarters of a point. The Bank of England’s key benchmark is 1.75%, and the Bank of Canada raised rates on Wednesday by three-quarters to 3.25%.



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