16-6-2023 (FRANKFURT) In a move aimed at curbing record-high inflation across the region, the European Central Bank (ECB) announced on Thursday that it would increase its main interest rate by 25 basis points to 3.5%. This decision contrasts with the US Federal Reserve’s decision to pause its own rate hikes the day before.
The ECB has been raising rates since July 2022 in an effort to tackle soaring inflation. However, the latest inflation figures indicate a faster-than-expected cooling, with headline inflation standing at 6.1% in May and core inflation (excluding volatile items) at 5.3%. These numbers remain significantly above the ECB’s target of 2% for headline inflation.
While market expectations aligned with Thursday’s rate increase, there is still considerable uncertainty surrounding the ECB’s future actions beyond the summer.
“The Governing Council’s future decisions will ensure that the key ECB interest rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary,” stated the ECB in a released statement.
Despite the recent easing in inflation, the ECB actually revised its projections upwards for both headline and core inflation for this year and the next. It now anticipates headline inflation at 5.4% in 2023, 3% in 2024, and 2.2% in 2025.
The ECB also adopted a more negative stance on growth in the upcoming years, downgrading its growth forecasts to 0.9% for this year and 1.5% in 2024. Three months ago, the estimate was 1% for this year and 1.6% for 2024.
Following the ECB’s announcement, the euro gained ground against the US dollar, while European bond yields saw an increase.
ECB President Christine Lagarde emphasized that the central bank is not considering a pause, unlike the US Federal Reserve. She indicated the possibility of another rate hike in July, stating, “Are we done? Have we finished the journey? No, we are not at [the] destination.” Lagarde acknowledged that the ECB is unsatisfied with the inflation outlook but cautioned that determining the terminal rate requires further evaluation.
Market observers have been speculating on when the ECB will conclude this rate-hiking cycle, particularly when the deposit rate reaches 3.75% or 4%.
Earlier this month, data revealed that the euro area experienced a technical recession in the first quarter of the year, with gross domestic product (GDP) contracting by -0.1%. The poor economic performance could limit the ECB’s ability to further increase rates to combat inflation. Nevertheless, ECB officials have previously indicated that curbing prices is more crucial than avoiding an economic slowdown.
