The European Central Bank said Thursday that it would carry out its first interest rate increase in 11 years in July, followed by another hike in September, as it catches up with other central banks worldwide in pivoting from supporting the economy during the pandemic to squelching soaring inflation.
The surprise announcement of two quarter-point increases came after the bank’s 25-member monetary policy council met in Amsterdam, saying inflation had become a “major challenge” and that those forces had “broadened and intensified” in the 19 countries that use the euro currency. It also will end its economic stimulus program next month.
The move underlines concerns about the level of annual consumer price increases, which hit 8.1% in May, the highest since statistics started in 1997. The bank’s target is 2%.
The ECB held out the possibility that it would make a more drastic, half-percentage-point increase in September rather than the more usual quarter-point adjustment, saying that if the inflation outlook persists or deteriorates, “a larger increment will be appropriate at the September meeting.”
The U.S. Federal Reserve raised it’s key rate by a half-point May 4 and has held out the prospect of more such large increases. The Bank of England has approved hikes four times since December.
The prospect of rapid central bank rate increases has sent shudders through stock markets, as higher rates would raise the returns on less risky alternatives to stocks. Raising rates in Europe is also complicated by weakening prospects for economic growth as Russia’s war in Ukraine sends shock waves through the global economy.
Higher rates can make credit more expensive for businesses. The bank’s statement said, however, that the path of increases would be “gradual but sustained.”
Markets are now waiting to hear more detail from bank President Christine Lagarde at her post-meeting news conference. The meeting was held in Amsterdam as one of the bank’s occasional gatherings away from its headquarters in Frankfurt, Germany.
“High inflation is a major challenge for all of us,” the bank said in its policy statement. “The governing council will make sure that inflation returns to its 2% target over the medium term.”
Higher rates are the usual tool to combat inflation. By raising its benchmarks, the central bank can influence what financial institutions, companies, consumers and governments have to pay to borrow the money they need. So higher rates can help cool off an overheating economy.
But higher rates can also weigh on growth. That makes the ECB’s job a delicate balance between snuffing out inflation and blunting economic activity.
The ECB on Thursday slashed its growth projection for this year to 2.8% from 3.7%.
It raised its outlook for inflation, saying that price increases would average 6.8% this year, higher than the 5.1% forecast in its March outlook, while the crucial forecast for 2024 was raised to 2.1% from 1.9%. That is significant because it indicates the bank sees inflation as above target for several years, a strong argument for more rate increases.
An ECB move to attack on inflation has raised concerns about the impact of higher interest rates on heavily indebted governments, most notably Italy.
The rate hikes end an extended period of extremely low rates that started during the global financial crisis in 2009. The increases would start from record lows of zero for its lending rate to banks and minus 0.5% on overnight deposits from banks.