Economy

Interest rates: European Central Bank sets record hike to fight inflation

The move will take the benchmark rate for the 19 countries using the euro to 0.75%. It follows the central bank’s first hike since 2011 in July, when rates were increased to zero after years in negative territory. It expects to hike rates over the next “several meetings,” the ECB said in a statement.

“The Governing Council took today’s decision, and expects to raise interest rates further, because inflation remains far too high and is likely to stay above target for an extended period,” the ECB added.

Eurozone inflation hit 9.1% in August, driven by the soaring cost of energy and rising food prices.

Europe has been trying to wean itself off Russia’s fossil fuel exports since the invasion in February. Moscow has responded by slashing flows of natural gas to Germany and other EU countries — sending prices soaring and forcing governments to spend hundreds of billions subsidizing bills for businesses and households.

Decades-high inflation is already taking its toll: recent surveys suggest that business activity fell in August for the second straight month, with Europe’s biggest economy — Germany — suffering a particularly marked decline. The region’s gross domestic product, the broadest measure of its economy, could shrink in the third quarter. Economists are warning that a European recession is looming.

But the central bank is worried that the energy price shock is already feeding expectations for higher inflation in the medium term. That could make the task of bringing it back to the ECB target rate of 2% significantly more difficult.

“Price pressures have continued to strengthen and broaden across the economy, and inflation may rise further in the near term,” the ECB said.

It now expects inflation to average 8.1% this year, and 5.5% in 2023, up sharply from its previous forecasts. Economic growth, meanwhile, would come in weaker than it was expecting at 3.1% this year, and just 0.9% next year.

“There seems universal agreement that higher rates are required to prevent higher inflation becoming embedded, though [Russian] President Putin is creating a lot of slack in the European economy already,” said Kit Juckes, a strategist at Societe Generale.

Speaking to reporters, ECB President Christine Lagarde acknowledged that in a “downside scenario,” including a complete suspension of Russian gas to Europe and widespread energy rationing, Europe would slump into a recession with the economy contracting by 0.9% in 2023.

“It still seems likely that, once the ECB realizes the depth of the recession that we expect to unfold, the ECB will put rate hikes on hold at some time in early 2023,” noted Holger Schmieding, chief economist at Berenberg.

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