The European Central Bank hiked its key interest rate to a record high on Thursday, pressing its fight against stubbornly high inflation that has been plaguing consumers – even as worries grow that higher borrowing costs could help push the economy into recession.
The increase of a quarter-percentage point comes as central banks around the world, including the Federal Reserve of the United States, try to judge how much anti-inflation medicine is too much – and what’s the right point to halt their swift series of rate hikes before the economy tips into a downturn and people lose their jobs.
“Inflation has declined, and we want it to continue to decline and to reinforce that process,” ECB President Christine Lagarde said at a news conference. “And we are doing that not because we want to force a recession, but because we want price stability to be there for people who are taking the brunt of inflation.”
Nevertheless, the bank signalled that its 10th straight hike could be its last, shifting its emphasis from raising rates to keeping them high enough for long enough to beat down inflation.
Thursday’s decision raises the ECB’s benchmark deposit rate to 4 per cent, up drastically from minus 0.5 per cent just a little more than a year ago and the highest since the euro was established in 1999.
Lagarde reiterated that interest rate levels “will make a substantial contribution to bringing down inflation”, and that borrowing costs would stay high “for as long as necessary”. Analysts said those statements indicate that this rate hike would likely be the last.
“The ECB’s communication was clear: today was the last hike in the current cycle,” said Carsten Brzeski, chief eurozone economist for ING bank.
“Looking ahead, a further weakening of the economy and more traction in a deflationary trend will make it very hard to find arguments for yet another rate hike before the end of the year,” Brzeski said.
Annual inflation of 5.3 per cent in the 20 countries that use the euro currency is well above the bank’s target of 2.0 per cent, robbing consumers of purchasing power and contributing to economic stagnation.
But there is the growing awareness that higher borrowing costs are weighing on decisions by consumers and businesses to invest and spend and are becoming a burden on the economy.
Interest rates combat inflation by raising the cost of credit for things people want to buy, particularly houses, and for business investment in buildings and equipment. That cools off demand for goods and relieves upward pressure on prices.
The flip side is that rate hikes can hurt economic growth if they’re overdone.
Europe’s major economies – Germany, France, Spain and Italy – saw shrinking activity in August in the services sector even at the tail end of a strong tourism summer in Spain and Italy, according to S&P Global’s surveys of purchasing managers. Services is a broad category that includes hotel stays, haircuts, car repairs and medical treatment.
That comes on top of a slowdown in global manufacturing that is hitting Germany, Europe’s biggest economy, particularly hard.
The eurozone economy has been teetering on the edge of recession since last year, barely growing in each of the first two quarters of this year.
Yet the economic picture does not resemble a typical recession because unemployment is at a record low of 6.4 per cent. Labour shortages have sent people’s pay higher – one factor complicating the ECB’s inflation fight.
Also weighing on the outlook is a weaker euro against the strengthening US dollar as investors take the view that economic weakness will hit Europe and China. They are betting that the US Federal Reserve might manage a ‘soft landing’ by finishing its rate hikes without pushing the economy into a downturn.
The Fed made its 11th rate increase in July, bringing its key rate to the highest level in 22 years after pausing in June. Economists and investors generally expect the Fed to skip a rate hike at its meeting next week, but it could increase again in November.
Inflation is lower in the US – at 3.7 per cent – than in Europe despite an upward bump from gasolene prices in August.
Central banks around the world have been hiking rates to stamp out inflation that broke out after the sharp economic rebound from the COVID-19 pandemic strained supply chains and Russia’s invasion of Ukraine sent food and energy prices higher.