ECB raises rates by 75 basis points

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The European Central Bank has raised interest rates by 75 basis points to tackle record inflation, despite fears that the eurozone is already heading into recession because of soaring energy prices.

The move, which matches the ECB’s previous biggest increase in borrowing costs, lifts the bank’s benchmark deposit rate from zero to 0.75 per cent — the highest level since 2011.

The central bank said it expected “to raise interest rates further” in the coming months.

“Inflation remains far too high and is likely to stay above target for an extended period,” the bank added. Prices rose 9.1 per cent in the year to August – a fresh record high.

The euro moved between small gains and losses against the dollar in the minutes after the ECB rate rise announcement, hovering close to parity with the greenback. Europe’s regional Stoxx 600 share index traded flat.

It is the second consecutive increase in borrowing costs by the ECB, which raised rates in July for the first time in more than a decade.

The rise comes in spite of mounting fears that the currency area will fall into recession in the coming months as surging energy prices — largely the result of Russia’s throttling of key European gas supplies — hit businesses and households throughout the region.

However, inflation is well above the ECB’s 2 per cent target, while the jobless rate is at a record low of 6.6 per cent in July. The euro also dropped to a 20-year low against the dollar, raising the price of imports.

Such developments bolstered the case for the ECB to take more aggressive action to rein in inflation, even if it costs jobs and growth. The last time the ECB raised rates by 0.75 percentage points was a three-week technical adjustment to smooth the euro’s launch in January 1999.

The ECB said its main refinancing rate for bank liquidity would increase from 0.5 per cent to 1.25 per cent. The rate on its marginal lending facility for overnight loans to banks would rise from 0.75 per cent to 1.5 per cent.

In government bond markets, the yield on the two-year German note — which is sensitive to changes in interest rate expectations — added 0.06 percentage points to 1.15 per cent as the price of the debt instrument slipped lower. The 10-year Bund yield, seen as a proxy for borrowing costs across the eurozone, rose 0.02 percentage points to 1.59 per cent.

The equivalent Italian yield was broadly steady at 3.87 per cent.

The ECB has lagged behind most major central banks in its response to high inflation. The US Federal Reserve is widely expected to announce a third consecutive 75 basis point rise at its meeting this month, which would lift the federal funds rate to a target range of 3 per cent to 3.25 per cent.

“The ECB has joined the 75 basis point club,” said Seema Shah, chief global strategist at Principal Global Investors, adding that the move was “testament to the enormity of the inflation challenge facing the central bank”.

The ECB also unveiled new forecasts that showed a serious deterioration in the growth outlook and much higher inflation expectations compared with its June predictions.

Growth would fall from 3.1 per cent this year to 0.9 per cent next year and 1.9 per cent in 2024, it said. That was a marked reduction from its previous forecasts for growth to slow only moderately from 2.8 per cent this year to 2.1 per cent in the next two years. 

“Very high energy prices are reducing the purchasing power of people’s incomes and, although supply bottlenecks are easing, they are still constraining economic activity,” the ECB said.

However, unlike many economists, the bank does not expect a recession — two consecutive quarters of falling output — instead predicting the economy would “stagnate later in the year and in the first quarter of 2023”.

The central bank raised its inflation forecast for this year from 6.8 per cent to 8.1 per cent and for next year from 3.5 per cent to 5.5 per cent. Its 2024 inflation forecast was increased from 2.1 per cent to 2.3 per cent.

Underlining the worsening economic prospects for the eurozone’s largest economy, the Kiel Institute for the World Economy slashed its forecast for German growth next year by 4 percentage points to minus 0.7 per cent on Thursday, warning: “With the high import prices for energy, an economic avalanche is rolling towards Germany.”

So far the hard data for the eurozone economy up to this summer has remained surprisingly resilient. Growth rose by an unexpectedly strong 0.8 per cent in the second quarter, bolstering the case of the hawkish ECB policymakers pushing for more “forceful” action on rates.

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