The ECB raised Interest Rates to a New Record
The European Central Bank raised its key interest rate to a record high of 4% on Thursday, but with the Eurozone economy stagnating, signaled that this was likely to be its last move in its more than year-long fight against inflation.
The central bank of the 20 countries that share the euro revised its forecasts for inflation, which it now expects to fall more slowly to its 2% target over the next two years. At the same time, it worsened its forecasts for economic growth.
It illustrated the dilemma facing the ECB at the meeting: Prices are still rising at more than twice the target rate, but because of high borrowing costs and the slowdown in China, overall economic activity is struggling to grow.
Against this background, the ECB sent a signal that it is probably done with raising interest rates, which will lead to a fall in the yield of bonds in the Eurozone and an increase in the price of European shares, adds "Reuters".
"Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels which, sustained over a sufficiently long period of time, will contribute significantly to a timely return of inflation to the target," the ECB said.
This is now expected to happen more slowly than the ECB's previous forecasts in June indicated, with inflation expected to be 5.6% in 2023, 3.2% in 2024 and 2.1% in 2025.
ECB Governor Christine Lagarde did not outright rule out a further hike if needed and said interest rates would have to remain at restrictive levels for some time. "The focus will move forward to the duration, because we can't say that now we're at the top," she said at a news conference.
Lagarde acknowledged that some ECB board members had opposed the latest rate hike, but added: "There was a solid majority of governors who agreed with the decision we took."
Asked to comment on whether the ECB's downgrade of growth forecasts - with Eurozone growth this year now at just 0.7% - meant a regional recession was now its main scenario, Lagarde insisted the slowdown was temporary. "The recovery we had planned for the second half of 2023 has been pushed back in time," she said. "We are confident that growth will pick up in 2024."
Thursday's 25-basis-point increase lifted the rate the ECB pays on bank deposits to 4.0%, the highest level since the introduction of the euro in 1999. Just 14 months ago, the rate was at a record low of minus 0.5%, which meant that banks had to pay to deposit their money safely with the central bank. Ahead of this week's meeting, money markets expected the deposit rate to peak at 4.0% before being cut in the second half of next year.
The tumultuous tightening cycle - twice as steep as typically predicted by the ECB's own stress tests of the banking sector - has already taken its toll on the Eurozone economy. As the manufacturing sector (which normally needs more capital to operate) is already suffering as a result of higher loan servicing costs, new lending to companies and households has fallen sharply. Services also began to struggle after a brief post-pandemic boom in tourism.
Germany, the Eurozone's largest economy, is going through an industrial decline and heading for recession, according to several forecasts.
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