The European Central Bank (ECB) has confirmed it will raise interest rates in a bid to bring down soaring prices across the eurozone.
The hike will be of 0.25 percentage points, in line with what most analysts had expected, and will take place in July, ECB President Christine Lagarde said on Thursday.
Another hike will happen in September, which might be larger than 0.25 if inflation “persists or deteriorates.”
The announcement marks the first increase in interest rates since 2011 and closes a long chapter of loose monetary policy.
“High inflation is a major challenge for all of us,” Lagarde said after a meeting of the Governing Council in the Netherlands.
“Based on our current assessment, we anticipate that a gradual but sustained path of further increases in interest rates will be appropriate.”
For months, Lagarde had used the word “temporary” to describe rising inflation. But after Russia launched its invasion of Ukraine, economic forecasts were turned upside down and the trend further exacerbated.
Pushed by the war, a persistent power crunch and fresh supply chain disruption, inflation in the eurozone hit a record-breaking 8.1% in May, four times the 2% annual target desired by the central bank.
Consumers and companies are now faced with unpredictable prices, putting policy-makers under pressure to deliver tangible solutions, even if there’s little they can do in the short term to make a difference.
Inflation is haunting other developed economies, whose banks have already signalled their intention to bump interest rates before stagflation takes hold.
The ECB expects inflation to remain “undesirably” high for the next couple of years: 6.8% in 2022, 3.5% in 2023 and 2.1% in 2024.
“Russia’s unjustified aggression towards Ukraine is severely affecting the euro area economy and the outlook is still surrounded by high uncertainty,” Lagarde said. “But the conditions are in place for the economy to continue to grow and to recover further over the medium term.”
Lagarde credited the lifting of coronavirus restrictions, the strong labour market, fiscal support and the savings amassed by citizens during the pandemic as factors that can keep the economic moving forward, albeit at a more modest pace than previously projected.
First hike since 2011
The ECB’s move will directly change the deposit facility rate, which sets the interest that other banks receive for depositing money with the ECB overnight.
The rate was downgraded to 0.00 in July 2012, at the peak of the sovereign debt crisis, and was later cut down four more times, descending all the way to -0.50 in September 2019.
Thursday’s announcement means the rate will go up to -0.25 in July and get out of negative territory in September, “normalising our monetary policy,” as Lagarde put it.
The rates on the main refinancing operations and the marginal lending facility will see an increase of equivalent size.
In another sign of times, Lagarde announced the end of the asset purchase programme (APP), an unconventional measure that was also introduced during the debt crisis to ensure price stability.
Under the programme, the ECB buys government and corporate bonds and other asset-backed securities, worth between €15 billion to €80 billion per month.
By ending the APP and hiking rates in July, the ECB intends to make borrowing more expensive for consumers and businesses in order to curtail demand and stimulate a gradual reduction in prices.
“If demand were to weaken over the medium term, it would lower pressures on prices,” Lagarde said.
A rise in interest rates also ensures that those who lend money now don’t lose value when they are paid back in the future.
The measure, however, could affect indebted countries, like Italy, Greece and Spain, who have for years relied on the ECB’s negative rate policy to obtain liquidity more easily and finance their debts.
Thursday’s announcement was largely anticipated by markets and investors, who had spent the last weeks speculating how far Lagarde would be willing to go. At the end, she opted for a careful 0.25 rise rather than a sudden 0.50 bump, like a few member states had suggested.