European Central Bank confirms first rate rise in over a decade next month

The European Central Bank (ECB) today confirmed it will hike rates for the first time in over a decade in a sign that the era of loose policy and low inflation is coming to an end.

President Christine Lagarde and co said the central bank will lift rates 25 basis points next month, which will mark the first increase in the eurozone since 2011.

The central bank also hinted it will hike rates 50 basis points if the inflation profile in the eurozone continues on its current upward trajectory.

“If the medium-term inflation outlook persists or deteriorates, a larger increment will be appropriate at the September meeting,” the ECB said.

Central banks tend to move in 25 basis point increments. 

The ECB also said it will stop buying bonds on 1 July. 

Latest data shows prices rose 8.1 per cent over the last year in the eurozone, the fastest acceleration since the creation of the euro in 1999. Lagarde said at a press conference after the rate announcement that inflation is a “major challenge for us all”.

However, this tradition was scrapped by the US Federal Reserve, who lifted borrowing costs 50 basis points at its last meeting as it scrambles to rein in policy to tame a 40 year high inflation rate.

In a sign of how concerned the ECB is about the inflation horizon, it raised its inflation projections again and now expects it to average 6.8 per cent this year versus a previous forecast for 5.1 per cent. 

The cost of living will average 3.5 per cent in 2023 and 2.1 per cent in 2024, marking four successive years of the ECB missing its two per cent target.

The world’s biggest monetary authorities are in the process of turning off the ultra-stimulative policy that has characterised the global economy since the financial crisis and was ramped during the Covid-19 crisis to tame the worst bout of inflation in a generation.

Higher interest rates tend to cool inflation by sucking demand out of an economy. Central banks have been accused of stoking inflation by leaving the money taps on for too long.

The likes of the ECB, Fed and Bank of England are, however, walking a tight line between getting on top of inflation without dealing unnecessary long term damage to their respective economies.

Price pressures are being driven by a combination of lingering Covid-19 restrictions hobbling trade flows, Russia’s invasion of Ukraine and shallower labour pools.

The ECB, alongside the Fed and the Bank of England, have hoovered up government and corporate debt since the financial crisis and the Covid-19 crisis in a bid to stimulate demand and get inflation above historically low levels.

The ECB is still lagging behind the Fed and the Bank of England, both of whom have already started their rate hike cycles to tame inflation.

The Bank is expected to hoist rates for the fifth meeting in a row next Thursday, likely taking them to 1.25 per cent.

The ECB, unlike the Bank and the Fed, will not sell bonds on its balance sheet and will continue to reinvest the proceeds from these assets.

Growth on the Continent will come in lower than first thought, the ECB said.

Countries in the eurozone with a weaker fiscal position, such as Italy and Spain, will be more exposed to the impact of higher rates in the bloc, whereas the likes of Germany and the Netherlands have greater capacity to absorb higher borrowing costs.