The European Central Bank (ECB) has increased interest rates by 0.75% up to 1.25%, to combat high inflation across the eurozone, in what is a significant rise following a unanimous decision from its Governing Council.
So far, the ECB has lagged behind the more hawkish United States’ Federal Reserve over increasing rates which climbed up to 2.5% in July. Today, the ECB hiked rates by 0.75% to a total of 1.25%.
Many analysts believed that a smaller rate rise of 0.50% was an option.
The ECB’s rate rise of 0.5% in July last year was the first hike since 2016, ending the era of the benchmark zero interest rate.
Soaring inflation across the eurozone provoked the ECB into rate rise action.
According to Eurostat, annual eurozone inflation rose to 9.1% in August, a month on month increase of 0.2%. This was the ninth consecutive CPI increase in the eurozone.
In September 2021, inflation was a comparatively low 3.4%, and it was 5.1% at the start of 2022.
Unsurprisingly, rising energy costs have spearheaded price rises, and escalated in August by a huge 38.3%, while food prices also accelerated up to 10.6%, almost one point higher than in July.
It is widely anticipated that inflation will rise to a level above 10% before the end of 2022.
More Rate Rises Soon
Based on its current assessment of spiraling inflation and economic headwinds, the ECB’s Governing Council expect that there will be further rate rises to come soon.
Many economists fear the eurozone will plunge into a deep recession due to the reliance on Russian gas for major economies such as Germany, as Russia has turned off the key Nord 1 gas pipeline.
Moscow recently said that it will resume gas supplies via Nord 1, only when all sanctions against Russia are lifted.
Lagarde Hails Move
ECB President Christine Lagarde has said that the interest rate hike is a “major step” in the fight against current conditions, and that it frontloads a transition to higher levels of interest rates that will return inflation back to the desired 2% target.
It has been forecasted by policymakers that eurozone inflation will eventually fall to 2.1% in 2024.
Lagarde also emphasised that the high energy prices and the effects of the Ukraine conflict were hitting the confidence of households and businesses, and that weakening global demand as interest rates rise across the world will hurt the eurozone.
Lagarde also revealed that the ECB has drawn up a “really dark downside scenario” in which the eurozone will be plunged into a recession next year.
A total shut down of the Russian gas supply was included in the projection, assuming a rationing of the national energy supply.
With the UK unveiling an extensive package where borrowing will fund an energy cap alleviating the pressure on households and businesses, Lagarde warned that energy bailouts should only be targeted towards those most in need, as universal energy support could further fuel inflation.
Euro Fall is Inflationary
Lagarde also pointed out that the depreciating euro adds to the inflationary pressures in the eurozone. This week saw the EUR/USD currency pair fall to an 18 year low.
The Euro’s troubles against the greenback continued following the rate announcement, and has again fallen to below parity at 0.9987, a drop of 0.19%.
However, the EUR/GBP currency cross has remained stable, with the Euro maintaining its recent dominance over the ailing British Pound.