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The European Central Bank’s biggest-ever rate hike came after the U.S. Federal Reserve and other central banks quickly raised rates around the world to curb record inflation that is squeezing consumers and pushing Europe into recession.
The bank’s 25-member governing board raised its key benchmark for the 19 countries that use the euro by an unprecedented three-quarters of a percentage point.
Since the introduction of the euro in 1999, the ECB has routinely raised interest rates by 25 basis points and has never raised its main bank lending rate by 4 basis points.
Central Bank President Christine Lagarde said the ECB will raise interest rates “in the next few meetings” as inflation “is likely to remain above our target for an extended period”. It hiked rates by half a percentage point at its July meeting for the first time in 11 years.
At the same time, she said, “the economy is expected to slow significantly for the rest of the year”, adding that energy prices will remain “unusually high”.
The bank said it expected more rate hikes ahead as “inflation could rise further in the near term,” noting that the economy was expected to “stagnate later in the year.”
The move comes after the European Central Bank raised rates by half a percentage point at its last meeting in July, the first rate hike in 11 years.
The big increases are designed to raise borrowing costs for consumers, governments and businesses, which would in theory slow spending and investment and cool soaring consumer prices by reducing demand for goods.
Analysts said it also aimed to boost the bank’s credibility after it underestimated the duration and severity of the inflation burst.
After hitting a record 9.1% in August, inflation is likely to rise to double digits in the coming months, economists said.
The war in Ukraine has fueled inflation in Europe, and Russia has slashed the supply of cheap natural gas for heating, power generation and operating factories. This has pushed up the price of natural gas by a factor of 10 or more.
European officials have denounced the spending cuts as extortion aimed at pressuring and dividing the EU over its support for Ukraine. Russia has blamed technical problems and this week threatened to cut off energy supplies entirely if the West imposes price caps on Moscow’s gas and oil.
Economists say the ECB’s rate hikes could deepen a recession in Europe expected at the end of this year and early 2023, as rising inflation makes everything from food to utilities more expensive.
Energy prices are out of the ECB’s control, but the ECB believes that rate hikes will prevent higher prices from being factored into expectations for wage and price trades, and decisive action now will prevent the need for further rate hikes if inflation becomes entrenched sex.
Holger Schmieding, chief economist at Berenberg Bank, said the ECB “wanted to fight inflation – and wanted to be seen as fighting inflation”.
He added that while energy prices and government support programs to protect consumers from some pain, “have a much bigger impact on inflation and the depth of the looming recession than monetary policy”.
Higher interest rates can help fight inflation by increasing the euro’s value against the dollar and other currencies.
That’s because the euro recently fell below $1, driven by soaring energy costs and a gloomy economic outlook, making imports, including energy, more expensive.
The European Central Bank has lagged other global central banks in raising interest rates. Central banks around the world have been left in limbo as inflation sparked by Russia’s war in Ukraine and the lingering effects of the Covid-19 pandemic have driven up energy prices and restricted the supply of components and raw materials.
The sudden rate hike comes after several years of low borrowing costs and inflation due to broad trends such as globalization, population ageing and digitization.
The ECB’s benchmark is now 1.25% of lending to banks. The Fed’s main benchmark rate is 2.25% to 2.5% after several big rate hikes, including two in four quarters. The Bank of England’s main benchmark rate is 1.75%, and the Bank of Canada raised its benchmark rate by three-quarters of a point on Wednesday to 3.25%.
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