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ECB increases interest rates by 0.5%, signals more hikes to come

By December 18, 2022No Comments

The European Central Bank raised interest rates for the fourth time in a row today, although by less than at its last two meetings.

It also pledged further hikes and laid out plans to drain cash from the financial system as part of its fight against runaway inflation.

The ECB has been raising rates at an unprecedented pace to rein in prices that have soared since economies reopened after the Covid-19 pandemic, driven by supply bottlenecks and then surging energy costs following Russia’s invasion of Ukraine.

The ECB raised the interest rate it pays on bank deposits from 1.5% to 2% today, moving further away from a decade of ultra-easy policy after being wrong-footed by the sudden rise in prices.

But the decision marked a slowdown in the pace of tightening from 75-basis-point hikes at each of the ECB’s two previous meetings, as inflation shows signs of peaking and a recession looms.

The decision was in line with economists’ expectations and mirrored similar rate hikes at the Bank of England today and the US Federal Reserve last night.

But like the Bank of England and the Fed, the ECB flagged even higher borrowing costs ahead to persuade investors it is still serious about fighting inflation, which could stay above the ECB’s 2% target through 2025.

“The Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target,” the ECB said.

The ECB also laid out plans to stop replacing maturing bonds from its €5 trillion portfolio, reversing years of asset purchases that have turned the central bank into the biggest creditor of many euro zone governments.

Under the plan, the ECB will reduce monthly reinvestments from its Asset Purchase Programme by €15 billion starting in March and revise the pace of balance-sheet reduction from July.

The move, which mops up liquidity from the financial system, is designed to let long-term borrowing costs rise and follows a similar step by the Fed earlier this year.

European shares extended losses and the euro gained against the pound and the yen after the ECB’s decision.

“We judge that interest rates will still have to rise significantly and at a steady pace,” ECB President Christine Lagarde told a news conference, saying further 50-basis-point rises should be expected for “a considerable amount of time”.

“We will sustain the course – it will not be enough to hit and withdraw.”

Ms Lagarde said inflation risks were still skewed to the upside, citing the possibility of a bout of higher-than-expected wage growth and of government support measures that ended up boosting demand across the 19-member euro zone economy.

But today’s ECB statement said it currently expected any recession to be “relatively short-lived and shallow”.

Meanwhile, the European Central Bank today raised its inflation projections for the euro zone and said price growth would remain above its 2% target throughout a projection horizon that now extends to 2025.

The ECB has persistently underestimated inflation over the past two years, and the bank has raised interest rates at four successive meetings to tame unexpectedly persistent price pressures.

The bank now sees inflation in the 19-country currency bloc at 6.3% next year, compared with expectations for 5.5% made in September.

Its 2024 forecast was raised to 3.4% from 2.3% while, in its first estimate for 2025, the ECB sees inflation then at 2.3%.

Initially driven by post-Covid supply chain bottlenecks, inflation has been surging on sky-high energy prices, but food and services costs are now becoming increasingly prominent, making price growth relatively broad.

Economic growth will meanwhile suffer badly next year as a result of Russia’s war in Ukraine, particularly the impact of high energy prices.

The ECB now sees GDP growth at 0.5% next year compared with 0.9% forecast in September, while in 2024, it is projected at an unchanged 1.9%. In 2025, the ECB sees growth at 1.8%.

Commenting on today’s rate hike, Joey Sheahan, Head of Credit at Online Brokers, said it is another harsh blow for borrowers – just ahead of Christmas.

“On its own, the 0.5% December rate hike will easily add another €600 a year to the mortgage bills of a homeowner on a 30-year tracker mortgage of €200,000,” he said.

“The ECB rate now stands at 2.5% – up from the zero rate that it stood at before interest rates started to rise in July. At that rate, the mortgage repayments are costing the borrower €3,000 a year more than they did before July 2022,” he explained.

Mr Sheahan said the back-to-back ECB rate increases of recent months have been a short, sharp shock for tracker rate homeowners.

“Many of those on tracker mortgages will only feel the impact of the December rate hike in their January mortgage bill – and they will likely feel the pain of that increase more acutely in January because of a combination of the Christmas financial hangover and the steep energy bills facing so many this winter,” he said.

Article Source: ECB increases interest rates by 0.5%, signals more hikes to come – RTE

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