Interest rates will stay high ‘as long as necessary,’ the European Central Bank’s leader says

The head of the European Central Bank said Monday that interest rates will stay high enough to restrict business activity for “as long as necessary” to beat back inflation. Still, she sympathized with homeowners who have seen their mortgage payments jump.

Christine Lagarde said rates would stay high because upward pressure on prices “remains strong” in the 20 countries that use the euro currency. “Strong spending on holidays and travel” and increasing wages were slowing the decline in price levels even as the economy stays sluggish, she said. Annual inflation in the eurozone eased only slightly from 5.3% in July to 5.2% in August.

“We remain determined to ensure that inflation returns to our 2% medium-term target in a timely manner,” Lagarde told the European Parliament’s committee on economic and monetary affairs. “Inflation continues to decline, but is still expected to remain too high for too long.”

The ECB this month raised its benchmark deposit rate to an all-time high of 4% after a record pace of increases from minus 0.5% in July 2022.

“Do we also have on our mind… what pain it inflicts? It is on our mind, I can assure you,” Lagarde said during a question-and-answer period with lawmakers. “And yes, we know that 30% — 30% — of the households in the member states have variable interest rate mortgages. It is hard, we know that.”

She noted the burden of inflation on lower-income households that pay a larger share of their income on basics like energy, saying that returning inflation quickly to 2% was the answer.

“The faster it gets there, the more stable prices are, the less painful it will be going forward,” Lagarde said.

Analysts think the ECB may be done raising rates given signs of increasing weakness in the European economy. Other central banks, including the Bank of England and the U.S. Federal Reserve, held off on rate increases last week as they draw closer to the end of their rapid hiking campaigns.

Inflation broke out as the global economy rebounded from the Covid-19 pandemic, leading to supply chain backups, and then Russia invaded Ukraine, sending energy and food prices soaring.

Lagarde has said interest rates are now high enough to make a “substantial contribution” to reducing inflation if “maintained for a sufficiently long duration.” The bank sees inflation declining to an average of 2.1% in 2025 after hitting a record-high 10.6% in October.

Higher rates are central banks’ chief weapon against excessive inflation. They influence the cost of credit throughout the economy, making it more expensive to borrow for things like home purchases or building new business facilities. That reduces demand for goods and, in turn, inflation but also risks restraining economic growth.

The ECB’s higher rates have triggered a sharp slowdown in real estate deals and construction — which are highly sensitive to credit costs — and ended a yearslong rally in eurozone home prices.

Lagarde said the economy “broadly stagnated” in the first six months of this year, and incoming data points to “further weakness” in the July-to-September quarter.

She cited ECB forecasts that predict the economy to pick up as inflation declines, giving people more spending power, saying that “we do not have a recession in our baseline.”

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