The European Central Bank (ECB) announced on Thursday that it has raised its key interest rates to the highest level since the launch of the euro in 1999, but also signaled that it might be done with tightening monetary policy for now. The move comes as the ECB faces a challenging trade-off between fighting inflation and supporting growth in the eurozone.
ECB Raises Rates by 0.25 Percentage Points
The ECB decided to increase its deposit rate, which is paid on commercial bank deposits, from 3.75% to 4%. Its main refinancing operations, which provide the bulk of liquidity to the banking system, was increased from 4.25% to 4.5%. The marginal lending facility, which offers overnight credit to banks, was also increased by a quarter-point to 4.75%.
This marks the 10th consecutive rate hike by the ECB since September 2022, when it started to tighten monetary policy in response to rising inflation pressures. The ECB has raised its key rates by a total of 2.5 percentage points in the past year, making it the most aggressive central bank among major economies.
ECB Signals Pause in Rate Hikes
The ECB also hinted that it may have reached the peak of its rate-hiking cycle, as it expects inflation to gradually decline in the coming years. The ECB’s president, Christine Lagarde, said that the current level of interest rates will make a substantial contribution to the timely return of inflation to the target of 2%.
“Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target,” Lagarde said in a statement.
The ECB also revised its inflation and growth projections for the eurozone, reflecting the impact of previous rate hikes and a weakening outlook for global trade. The ECB now expects inflation to average 3.2% in 2024, down from 5.3% in 2023, but still above its target. Growth is expected to slow down to 0.7% in 2023 and 1% in 2024, from 1.8% in 2022.
ECB Faces Stagflation Risk
The ECB’s decision comes amid growing concerns about stagflation, a situation where high inflation is accompanied by low growth and high unemployment. The eurozone economy has been hit hard by the Covid-19 pandemic, the Russian invasion of Ukraine, and supply chain disruptions that have pushed up energy and commodity prices.
The ECB’s rate hikes have also weighed on consumer spending and business investment, as borrowing costs have increased for households and firms. Some economists have argued that the ECB has overreacted to inflation pressures that are largely driven by temporary factors, and that it should focus more on supporting growth and employment.
However, Lagarde defended the ECB’s policy stance, saying that inflation remains too high for too long, and that the central bank is determined to ensure that it returns to its target in a timely manner. She also said that the ECB stands ready to adjust its policy if needed, depending on the evolution of economic conditions and inflation expectations.
“The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary,” she said.