The European Central Bank raises interest rates to the highest level since 2001
The European Central Bank raised interest rates to their highest level in more than two decades on Thursday, warning that there was further to go to stop inflation.
Unlike the Federal Reserve, which left interest rates unchanged on Wednesday, policymakers who set interest rates for the 20 countries that use the euro said they had not even discussed pausing rate hikes at this week’s policy meeting.
“Are we done? Have we finished the journey? No, we are not at our destination,” Christine Lagarde, the president of the bank, told reporters in Frankfurt.
The bank raised interest rates by a quarter of a percentage point, setting the deposit rate at 3.5 percent, the highest since 2001, when officials said inflation was forecast to remain too high for too long. It was the bank’s eighth increase in a row. The move had been well telegraphed since the bank’s last board meeting in early May, when policymakers expressed concerns about underlying inflationary pressures from wage growth and corporate profits or the impact of rising food prices.
The decision came a day after the Federal Reserve held interest rates steady for the first time in more than a year. After last month’s mirrored move, when both raised interest rates by a quarter of a point, the two central banks have begun to diverge again. While the European Central Bank began raising interest rates from below zero last July, it still hasn’t raised rates for as long or as high as the Fed.
“We are not thinking about a break,” Lagarde said Thursday. It is “very likely” that the bank will raise interest rates again at its next meeting in July, she added, as long as there is not a “substantial change” in the bank’s inflation expectations.
Policymakers say they want to avoid the risk of declaring victory in the battle against rising prices too soon, even as the euro zone’s annual rate of inflation has fallen from its double-digit peak late last year to 6.1 percent in May, the slowest pace in more than a year . Much of the decline can be attributed to lower wholesale energy costs, but central bankers have been alert to signs that inflation is becoming embedded in the economy, which could prevent them from getting inflation back to the 2 percent target.
Highlighting the growing impact of wage increases on inflation, Lagarde said “wage pressures, while partly reflecting one-off payments, are becoming an increasingly important source of inflation.” Higher labor costs for businesses also explained why core inflation, which excludes energy and food costs, was expected to be higher over the next two years, she said.
Wage growth will be sustained, Lagarde said, especially in the short term as the summer travel and tourism season begins. While Lagarde is laying the groundwork for strong wage growth in the eurozone, unexpectedly fast wage growth in the UK has traders betting on higher interest rates there.
The European Central Bank estimates overall inflation to average 5.4 percent this year, but expects it to still be above the target in two years, at 2.2 percent, somewhat higher than previous estimates three months ago. This forecast of 2.2 percent was “not satisfactory,” Lagarde said.
As inflation slows, the question of how much policy tightening is the right amount has become difficult to measure. Too much can constrain the economy more than necessary and cause or worsen a recession. Too little can allow inflation to become a persistent problem that policymakers cannot eradicate. It is a challenge facing central bankers around the world.
On Wednesday, the Fed did not raise interest rates, saying it was taking time to assess how the US economy responded to the rapid pace of previous rate hikes. But politicians warned that they may have to raise interest rates again later. Such a pattern was recently established in Australia and Canada, where central banks kept interest rates stable for a short period before resuming their increases.
On Thursday, Ms. Lagarde that policymakers would know where to hold prices only when they got there.
Traders are still betting that the date will come in the autumn, either at the bank’s September or, more likely, October meeting.
“The ECB just talked its way into two more interest rate hikes,” Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, wrote in a note after Thursday’s announcement. Each of them, in July and September, will be a quarter of a point, leaving the deposit rate at 4 percent, where he predicted it would be. But economists at Berenberg bank and Commerzbank expect the ECB to stop after another increase, to 3.75 percent, and keep rates there throughout 2024.
In May, the European Central Bank reduced the pace of interest rate increases as it recognized the impact tighter monetary policy was having on the region’s economy through more restrictive lending conditions. On Thursday, the bank said that tighter financing conditions are expected to dampen demand further.
As the central bank signaled higher interest rates, it also lowered its forecasts for economic growth slightly, predicting the economy would grow 0.9 percent this year and 1.5 percent next year. The eurozone slipped into recession earlier this year as high prices prompted people to spend less.
The central bank’s next decisions “will ensure that the ECB’s key interest rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2 percent medium-term target,” it said in a statement, “and will be kept at these levels as long as is necessary.”
