As inflation reaches record levels and the 19 countries that use the euro head for a recession, the eurozone’s central bank announces its largest interest rate increase.
The European Central Bank (ECB) has increased its benchmark interest rates by a record-breaking 75 basis points, indicating that future increases are inevitable.
The bank, which determines monetary policy for the eurozone and the European Union, raised the deposit rate from zero to 0.75 percent on Thursday afternoon and the main refinancing rate to 1.25 percent, the highest level since 2011.
It comes at a time when inflation is at a half-century high and the bloc is expected to enter a winter recession.
In a statement, the ECB stated: “Over the course of the next several sessions, the Governing Council anticipates raising interest rates further to dampen demand and protect against the danger of a sustained upward shift in inflation expectations.”
Inflation is projected to average 8.1% this year, 5.5% in 2023, and 2.2% in 2024, under the bank’s revised economic outlook.
Inflation was initially fueled by energy prices – which were exacerbated by Russia’s invasion of Ukraine – but the recent drought is also contributing to its growth.
The ECB declared: “Inflation could rise higher shortly as price pressures have continued to intensify and spread across the economy.
This significant step accelerates the transition from the current relatively accommodating level of policy rates to levels that will ensure the rapid return of inflation to the ECB’s medium-term target of 2%.
The ECB forecasts this year’s GDP growth to be 3.1%, up from 2.8% in June but has lowered its 2023 forecast from 2.1% to 0.9%.
The decline of the Euro exerts upward inflation pressure.
Rob Clarry, the investment strategist for Evelyn Partners, stated: “Even though supply-side challenges, rather than excessive demand, have been the primary driver of inflation in the eurozone, the ECB has acted decisively to prevent higher inflation expectations from becoming entrenched.
“Attempting to arrest the euro’s depreciation relative to the U.S. dollar is vital for a second reason, as this has added to inflationary pressure.
“Fundamentally, it appears that the ECB adopts the same attitude as the Bank of England and the Federal Reserve: combating inflation at the expense of economic expansion.
Positives from which we can draw
“Despite the gloomy economic forecast, there are some benefits to consider.
“First, the eurozone has made significant headway in restocking its gas reserves ahead of winter; whether this will be sufficient depends on ongoing flows and winter weather conditions.
“Second, there appears to be a growing consensus within the bloc that governments should assist households by subsidizing their energy expenditures.
“Germany (€65 billion), Portugal (€2.4 billion), and the Netherlands (€16 billion) all announced aid packages this week.
This should support consumer spending as the eurozone attempts to avert a protracted economic downturn.
Initially, the euro surpassed parity versus the dollar in currency trading, but it has since declined. Early in the day, the pound fell to a new two-and-a-half-month low of 86.95 pence per euro before recovering slightly.
