European Central Bank hikes interest rates to combat inflation and leaves door open to more

ECB President Christine Lagarde said the bank’s next moves would be determined by what the data — including inflation and job numbers — will show

European Central Bank (ECB) President Christine Lagarde addresses a press conference following the ECB Governing Council meeting in Frankfurt am Main, Germany, 27 July 2023.
European Central Bank (ECB) President Christine Lagarde addresses a press conference following the ECB Governing Council meeting in Frankfurt am Main, Germany, 27 July 2023.RONALD WITTEK (EFE)

The European Central Bank raised interest rates for the ninth straight time Thursday in its yearlong campaign to stamp out painfully high inflation and kept the door open to further hikes despite increasing fears of recession.

ECB President Christine Lagarde had all but promised the quarter-percentage point increase and said the bank’s next moves would be determined by what the data — including inflation and job numbers — will show.

“We have an open mind as to what the decisions will be in September and in subsequent meetings,” she told reporters. “So we might hike and we might hold.”

Lagarde said that if the bank pauses, “it would not necessarily be for an extended period of time.” Decisions could vary from one meeting to the next, she said, but insisted that the ECB is “very strongly rooted in our determination to break the back of inflation.”

“Are we satisfied? Are we claiming victory? No. We want go to the end of the game,” she said.

U.S. Federal Reserve Chair Jerome Powell was similarly noncommittal about whether more rate increases might be coming after the Fed on Wednesday raised its key rate for the 11th time in 17 months.

Central banks around the world have been raising borrowing costs to combat inflation unleashed by higher energy prices after Russia invaded Ukraine and supply chain backups as the global economy recovered from the coronavirus pandemic.

Inflation in the 20 countries that use the euro currency has fallen from its peak of 10.6% in October to 5.5% in June — still well above the bank’s target of 2% considered best for the economy.

Households and businesses are facing a double hit from price spikes and higher rates, which make it more expensive for people to get loans to buy homes and cars or for companies to get new equipment or build facilities.

Rates are working their way through the economy, weighing on home prices and construction activity, and are designed to work so people spend less and prices come down. But they can also weigh on economic growth, and the eurozone already has seen back-to-back quarters of contraction.

With Thursday’s quarter-point increase, the ECB has raised its benchmark deposit rate from minus 0.5% to 3.75% in one year, the fastest credit tightening since the euro was launched in 1999.

With Lagarde pointing to possible further increases, “the ECB is again running the risk of being behind the curve. This time not by being too benign on inflation but rather by being too optimistic and too benign on the economic impact of its own policy measures,” said Carsten Brzeski, chief eurozone economist at ING Bank.

Lagarde acknowledged that “the economic outlook for the euro area has deteriorated” and will stay weak in the short run. But she said inflation is expected to fall and incomes to rise, helping the economy recover.

The rate hikes are already working: Home prices have started to decline after a yearslong rally, and business loans are at their lowest level since statistics started in 2003. The outlook for construction companies in Germany also hit its lowest level since 2010.

Fears about recession are focusing on Germany, Europe’s industrial powerhouse and largest economy. It is the only developed economy that the International Monetary Fund expects to shrink this year.

Germany already has recorded two straight quarters of falling economic output, meeting one definition of recession. A third is possible, with figures for the April-to-June period coming out Friday.

The German economy is going through a “slowcession” — “stuck in the twilight zone between stagnation and recession,” Brzeski says.

The whole eurozone economy also shrank slightly in the first three months of the year, likewise the second straight quarterly decline. Preliminary figures for the second quarter are due Monday.

The economists on the euro area business cycle dating committee, which declares recessions, use a broader set of data than just two quarters of shrinking output figures in its decisions. The committee said June 30 that talk of a eurozone recession was “premature” given record low unemployment of 6.5%.

ECB officials say getting tough on inflation now avoids even more drastic credit restrictions later if inflation becomes ingrained through expectations for higher wages and prices.

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