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ECB announces biggest interest rate hike in its history to tackle inflation

·Business Reporter, Yahoo Finance UK
·3-min read
President of the European Central Bank (ECB) Christine Lagarde
The move pushes the main refinancing rate to 1.25%, up from 0.5%, while the marginal lending rate paid by banks borrowing from the ECB goes up to 1.25%. Photo: Wolfgang Rattay/Reuters

The European Central Bank (ECB) has increased interest rates across the eurozone by a record amount as policymakers aim to curb runaway inflation.

The bank’s governing council voted to raise all three key interest rates by 75 basis points, or 0.75% percentage points — the biggest hike in its history.

This now pushes the main refinancing rate to 1.25%, up from 0.5%, while the marginal lending rate paid by banks borrowing from the ECB goes up to 1.25%.

It marks the second consecutive increase in borrowing costs after the central bank raised rates in July for the first time in more than a decade. This was after continued criticism that it was behind the curve, acting too slowly on inflation.

Christine Lagarde, president of the bank, said at a press conference on Thursday that the ECB plans to continue hiking interest rates in the future to dampen demand, and guard against a persistent upward shift in inflation expectations.

It comes after eurozone inflation hit a record high of 9.1% last month.

Read more: FTSE and European stocks slump as eurozone inflation hits record high

“The governing council took today’s decision, and expects to raise interest rates further, because inflation remains far too high and is likely to stay above target for an extended period,” the ECB said.

“According to Eurostat’s flash estimate, inflation reached 9.1% in August. Soaring energy and food prices, demand pressures in some sectors owing to the reopening of the economy, and supply bottlenecks are still driving up inflation.

“Price pressures have continued to strengthen and broaden across the economy and inflation may rise further in the near term.”

According to ECB forecasters, inflation is now expected to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024 — still above its 2% target.

Meanwhile, the jobless rate fell to a record low of 6.6% in July, and as the euro (EURUSD=X) dropped to a 20-year low against the dollar, pushing up the price of imports.

Watch: ECB finally hikes rates, and goes big

In a gloomy outlook on the future, the ECB predicted that the economy will stagnate later this year, and in the first quarter of 2023.

“Very high energy prices are reducing the purchasing power of people’s incomes and, although supply bottlenecks are easing, they are still constraining economic activity.

“In addition, the adverse geopolitical situation, especially Russia’s unjustified aggression towards Ukraine, is weighing on the confidence of businesses and consumers.”

Policymakers have cut their growth forecasts, with growth of 3.1% expected in 2022, just 0.9% next year, and 1.9% in 2024.

Read more: Energy bills: Liz Truss caps gas and electricity prices at £2,500

Altaf Kassamat at State Street Global Advisors said: “The ECB joined the Fed in hiking 75bps today, moving more aggressively than markets had priced in. To us, this move seemed inevitable as the ECB strove to regain its credibility given August’s inflation surprise, with both headline and core scaling new highs, and headline staying above the US for a second month.

“With core inflation more than double the ECB’s target and rising, it was impossible to argue that this inflation spike was ‘transitory’ and purely about energy.

“The ECB had to respond forcefully to criticism of falling behind the curve, especially with the worry that second-round effects were starting to taking hold. This hike was also about putting a floor under the Euro, and keeping a lid on the extra imported inflation its weakness had brought.”

Kassamat now expects the ECB to slow its pace of rate rises, hiking another 50bps in October and 25bps in December.

Watch: How does inflation affect interest rates