The European Central Bank made its largest-ever interest rate increase Thursday, following the US Federal Reserve and other central banks in a global stampede of rapid rate hikes meant to snuff out record inflation that is squeezing consumers and pushing Europe toward recession.
The bank’s 25-member governing council raised its key benchmarks by an unprecedented three-quarters of a percentage point for the 19 countries that use the euro currency. The ECB usually moves rates by a quarter-point and had never raised its key bank lending rate by three-quarters of a point since the euro’s launch in 1999.
The jumbo increase is aimed at raising the cost of borrowing for consumers, governments and businesses, which in theory slows spending and investment and cools off soaring consumer prices by reducing the demand for goods.
Analysts say it’s also aimed at bolstering the bank’s credibility after it underestimated how long and how severe this outbreak of inflation would be. After reaching a record 9.1% in August, inflation may rise into double digits in coming months, economists say.
The war in Ukraine has fuelled inflation in Europe, with Russia sharply reducing supplies of cheap natural gas used to heat homes, generate electricity and run factories. That has driven up gas prices by 10 times or more.
European officials decry the cutbacks as blackmail aimed at pressuring and dividing the European Union over its support for Ukraine. Russia has blamed technical problems and threatened this week to cut off energy supplies completely if the West institutes planned price caps on Moscow’s natural gas and oil.
Economists say the ECB’s interest rate hikes could deepen a European recession predicted for the end of this year and the beginning of 2023, caused by higher inflation that has made everything from groceries to utility bills more expensive. Energy prices are beyond the ECB’s control, but the bank has reasoned that rate hikes will prevent higher prices from being baked into expectations for wage and price deals and that decisive action now will forestall the need for even bigger hikes if inflation gets ingrained.
Europe’s central bank “wants to fight inflation – and wants to be seen as fighting inflation,” said Holger Schmieding, chief economist at Berenberg bank.
Though energy prices and government support programs to shield consumers from some of the pain will “have a much bigger impact on inflation and the depth of the looming recession than monetary policy,” he said.
Carsten Brzeski, chief eurozone economist at ING bank, also said the coming recession “will be driven by energy prices and not by interest rates.”
Higher rates could help the fight against inflation by raising the euro’s exchange rate against the dollar and other currencies. That’s because the euro’s recent slide to under $1 — driven by soaring energy costs and dampening economic prospects — makes imported goods, including energy, more expensive.
The ECB has lagged other global central banks in raising rates. Central banks worldwide scrambled after being wrong-footed by inflation fed by Russia’s war in Ukraine and the lingering effects of the COVID-19 pandemic, which have sent energy prices higher and restricted supplies of parts and raw materials.
The sudden campaign to raise interest rates follows years in which borrowing costs and inflation stayed low because of broad trends such as globalization, aging populations and digitalisation.
The ECB’s benchmark is now 1.25% for lending to banks. The Fed’s main benchmark is 2.25% to 2.5% after several large rate hikes, including two of three-quarters of a point. The Bank of England’s key benchmark is 1.75%, and the Bank of Canada on Wednesday raised its benchmark by three-quarters of a point, to 3.25%.