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ECB raises rates by 25 bps in bid to tame inflation

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The European Central Bank raised interest rates by 25 basis points to 3.25% as expected on Thursday and signalled that more tightening would be needed to tame inflation.

The central bank for the 20 countries that share the euro has lifted rates by a combined 375 basis points since last July, its fastest pace of tightening. But it made clear that further action was likely given mounting wage and price pressures.

That came a day after the U.S. Federal Reserve also raised its benchmark rate by a quarter of a percentage point – in its case to a 5.00-5.25% range – but hinted that could be the last in a historic series of hikes.

“We are not pausing – that is very clear,” ECB President Christine Lagarde told a press conference. “We know that we have more ground to cover.”

Lagarde said there were still big upside risks to inflation, notably from recent wage deals and high corporate profit margins, and that financial conditions were still not sufficiently tight. She noted that the bank’s written statement made reference to future “policy decisions” in the plural, possibly suggesting more than one further hike.

The ECB move, a slowdown after three consecutive 50 basis point increases, comes only days after euro zone banking data showed the biggest drop in loan demand in over a decade. That suggests previous rate rises are working their way through the economy and that ECB policies are now restricting growth.

“Rate decisions will continue to be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission,” the ECB said in a statement issued before the press conference.

It also said it would stop reinvesting cash from maturing debt in its 3.2 trillion euro ($3.5 trillion) Asset Purchase Programme from July.

Policymakers had been split in the run up to Thursday’s meeting between a 25 basis point and a 50 basis point rise, but markets and economists had overwhelmingly bet on the smaller increase after soft data in recent weeks and similar moderation by other big central banks, most recently the Fed on Wednesday.

Also supporting the case for a smaller move, the euro zone economy barely grew last quarter and banks were tightening access to credit, raising the risk that such a trend could morph into a full-blown credit crunch and drag further on growth.

Underlying inflation has also stopped rising – at least for the time being.

“Overall, the incoming information broadly supports the assessment of the medium-term inflation outlook that the Governing Council formed at its previous meeting,” said the ECB, which has missed its 2% inflation target for the past decade.

But like peers including the Bank of England, the ECB is still seen raising borrowing costs several times before a hitting peak rate of 3.75% some time this summer, as inflation could take years to come back to its 2% target.

Although overall inflation has fallen sharply from last autumn’s double-digit readings, underlying price pressures are still building, suggesting that price growth could level off above the ECB’s target unless the bank hikes further.

These risks are exacerbated by a tight labour market, especially since wage growth has been quicker than predicted and the jobless rate has fallen to an all-time-low despite the near-recessionary environment.

(Reuters)

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