European Central Bank hikes rates 25 basis points to 2001 and hints at more to come

The European Central Bank (ECB) today signed off what many thought would be its final interest rate rise, but lingering concerns about high inflation may lure the monetary authority into further increases, experts have bet.

The monetary authority of the 20 countries using the euro sent borrowing costs up 25 basis points to 3.5 per cent, the highest level since 2001.

ECB President Christine Lagarde and co have now raised rates at each of their last eight meetings, starting in July 2022, lifting them from negative territory into a more restrictive stance to tame rising prices.

Inflation in the continent peaked at around eleven per cent last autumn and has been falling ever since, raising market expectations that the Frankfurt-based central bank is would be finished with its tightening campaign after today’s meeting.

Prices climbed 6.1 per cent over the year to May, a marked drop from April’s rate of increase of seven per cent and a slower rise than the 6.3 per cent forecast by markets.

Core inflation – which strips out volatile food and energy prices – is still running high. The ECB today said further rate rises would be necessary “to achieve a timely return of inflation to the two per cent” target.

Its economists think there’s a greater chance inflation will hang around higher for longer, today projecting that core inflation will average 5.1 per cent this year, up from the 4.6 per cent previously expected. It will also average three per cent in 2024 and more than two per cent in 2025, the ECB reckons.

That forecast upgrade indicates Lagarde and co would be prepared to pile more pressure on households and businesses to unpick the stickiest drivers of inflation from the eurozone economy.

“Inflation has been coming down but is projected to remain too high for too long,” the central bank said.

Before the announcement, markets thought a 25 basis point rise would be the ECB’s last, although some now reckon after today’s decision more rises are on the way.

“President Lagarde all but promised another hike next month. Our baseline forecast remains that interest rates will peak in July and stay there until the middle of next year but the chances of another hike at the following meeting in September have risen,” Jack Allen-Reynolds, deputy chief eurozone economist at Capital Economics, said.

Growth forecasts were lowered to 0.9 per cent this year and 1.5 per cent next. The bloc slipped into a winter recession, revised figures last week revealed.

European inflation, much like the UK’s, was initially driven by a sudden burst in demand in spending after lockdowns ended colliding into squeezed supply.

However, it was given added impetus by Russia’s invasion of Ukraine snarling up international energy markets.

Europe, especially its big economies like Germany and Italy, have relied on cheap Russian gas to power economic output. 

Activity has receded as President Putin pulled supplies from the market in response to sanctions, although countries switched to liquified natural gas imports rapidly to replenish energy inventories.

The euro strengthened around 0.5 per cent against the US dollar after the eighth successive rate rise was announced.

Yesterday, the Federal Reserve skipped raising interest rates, adopting to wait and see the impact of its prior rate increases. Chair Jerome Powell opened the door to resuming rate increases in the summer.

An amalgamation of Fed officials’ end of year rate expectations – known as the “dot plot” – pitched borrowing costs rising two more times this year from their current level of five per cent to 5.25 per cent.

Bank of England officials next Thursday are tipped to possibly raise interest rates 50 basis points to five per cent after a string of data revealed Britain is suffering from the toughest inflation problem in the rich world. A 25 basis point rise is the most likely outcome.

Markets think Governor Andrew Bailey and co will back at least five more rises this year, sending borrowing costs to around six per cent, which would top the Fed and ECB.