Daniel Roland | Afp | Getty Images The European Central Bank on Thursday announced a rate hike of 75 basis points, raising its key deposit rate to 0.75%. “This important step furthers the transition from the prevailing ultra-accommodative level of policy rates to levels that will ensure a timely return of inflation to the ECB’s medium-term target of 2%,” it said in a statement. He added that he “expects to raise interest rates further because inflation remains very high and is likely to remain above target for a long time.” It revised down its inflation expectations, forecasting an average of 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024. Markets had largely priced in a 75 basis point gain, with the euro flat against the British pound and slightly higher against the dollar at 1.0005. On Monday, the euro fell below 99 cents for the first time in 20 years. The ECB’s move follows a rise of -0.5% to zero at its July meeting. The central bank, which sets monetary policy for the 19 nations that use the euro, has kept interest rates in negative territory since 2014 in a bid to boost spending and combat low inflation. The central bank now faces a very different problem, with eurozone consumer prices rising 9.1% in August, marking a ninth consecutive record high. Inflation is being fueled by low energy prices, which have soared since Russia invaded Ukraine in February. Price increases are also seen in sectors such as food, clothing, cars, home appliances and services. Factors including ongoing supply chain issues and the negative impact of recent heatwaves contributed to the price increase. Gross domestic product across the euro zone rose 0.8 percent in the second quarter, but many analysts say a euro zone recession is all but inevitable in the coming months as spending power tightens and businesses struggle to pass on higher input costs. As in the US, recession warnings come despite an extremely tight labor market, with unemployment across the bloc at a record low of 6.6%.
Falling recession risk
At the press conference that followed, ECB President Christine Lagarde said the central bank’s Governing Council had taken a unanimous decision to raise the three key interest rates. Lagarde said the bank remained dependent on session-by-session data and had been assessing inflation data and growth forecasts since its meeting last July. “While we conclude that energy is the main source of inflation, along with rising food, we also have inflation spreading across a range of goods and services where demand plays a role,” he said. “So, in the face of inflation that is extremely high, that is large and persistent across all sectors of this nature, decisive action had to be taken.” Countering accusations that the European Central Bank is lagging behind other major central banks in raising interest rates, Lagarde said she had started to normalize monetary policy since December, when she ended her asset purchase program. Asked by CNBC’s Annette Weisbach whether a recession was in the ECB’s forecasts, Lagarde said the bloc’s baseline outlook was for GDP growth of 3.1% in 2022, 0.9% in 2023 and 1, 9% by 2024, avoiding recession. However, the downside scenario, which accounts for risks including a complete disruption of Russian energy supplies to the rest of Europe and rationing, was for 2.9% growth in 2022, a 0.9% contraction in 2023 and 1.9% growth in 2023 . “The ECB and other central banks have been torn between the need to tame inflation and their realization that recession risks continue to rise,” said Willem Sels, global chief investment officer at HSBC. “Gas prices are rising sharply and we know the ECB is concerned that rising inflation is leading to higher wage demands, which could make inflationary pressures stickier. Monetary policy works with a lag and ECB governors may have judged that it is better for front load factor increases and to complete the hike by the end of the year,” he added in a note. Sels said bond markets and equity markets reacted with “some concern.” “Rises in interest rates will further increase the borrowing costs of regional countries and strengthen financial conditions, which may deepen the recession,” he added. The pan-European Stoxx Europe 600 fell 0.42% after the announcement, after a morning in the green Any bullish outlook on the euro would be unsustainable given expected Fed and Bank of England rate hikes, rising debt costs, a possible recession, the upcoming Italian election and geopolitical risk, Sells added. The pan-European Stoxx Europe 600 fell 0.42% after the announcement, after a morning in the green. Thursday’s rate hike keeps the ECB below its “neutral” rate of between 1% and 2%. Konstantin Veit, a portfolio manager at investment firm Pimco, told CNBC’s “Squawk Box Europe” on Thursday that it is now “undeniable” within the Frankfurt-based institution that it will reach that range before the end of the year. The “most interesting” question now, he said, was what his “end pace” — the highest point — would be during this hiking cycle. Markets will now look for clues as to whether it will move above the neutral range into tightening territory.
