The European Central Bank raised interest rates by a record three-quarters of a percentage point on Thursday and promised more action to come as it struggles to contain the inflationary fallout of the invasion of Ukraine by Russia and the ensuing energy crisis.
This decision will bring the reference rate of the 19 countries using the euro to 0.75%. It follows the decision of the central bank first hike since 2011 in July, when rates were cut to zero after years in negative territory. It expects a rate hike over the next “several meetings”, the ECB said in a statement.
“The Governing Council has taken today’s decision and expects to raise interest rates further, as inflation remains far too high and is expected to remain above target for an extended period,” he said. added the ECB.
Eurozone inflation hit 9.1% in August, driven by soaring energy costs and rising food prices.
Europe has been trying to wean itself off Russian fossil fuel exports since the February invasion. Moscow responded by reduce natural gas flows to Germany and other EU countries, driving up prices and forcing governments to spend hundreds of billions to subsidize business and household bills.
Inflation, high for decades, is already taking its toll: recent surveys suggest that business activity fell in August for the second month in a row, with Europe’s largest economy, Germany, suffering a particularly sharp decline marked. The region’s gross domestic product, the broadest measure of its economy, could contract in the third quarter. Economists warn that a European recession is looming.
But the central bank fears the energy price shock is already fueling expectations of higher inflation over the medium term. This could make the task of bringing it back to the ECB’s target rate of 2% much more difficult.
“Price pressures have continued to build and spread across the economy, and inflation could 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 forecast. Economic growth, meanwhile, would be weaker than expected at 3.1% this year and just 0.9% next year.
“There seems to be general agreement that higher rates are needed to keep higher inflation from taking hold, although [Russian] President Putin is already creating a lot of slowdown in the European economy,” said Kit Juckes, strategist at Societe Generale.
Speaking to reporters, ECB President Christine Lagarde acknowledged that under a “pessimistic scenario”, including a complete suspension of Russian gas to Europe and widespread energy rationing, Europe would would collapse 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 we expect, it will suspend rate hikes at some point in early 2023,” noted Holger Schmieding, chief economist at Berenberg.