FRANKFURT—The European Central Bank raised interest rates for the fourth time in a row on Thursday, although by less than at its last two meetings, pledged further hikes and laid out plans to drain cash from the financial system as part of its fight against runaway inflation.
The ECB has been raising rates at an unprecedented pace to rein in prices that have soared since economies reopened after the COVID-19 pandemic, driven by supply bottlenecks and then surging energy costs following Ukraine’s conflict.
The central bank for the 19-country eurozone raised the interest rate it pays on bank deposits from 1.5 percent to 2 percent on Thursday, moving further away from a decade of ultra-easy policy after being wrong-footed by the sudden rise in prices.
But the decision marked a slowdown in the pace of tightening from 75-basis-point hikes at each of the ECB’s two previous meetings, as inflation shows signs of peaking and a recession looms.
The decision was in line with economists’ expectations and mirrored similar rate hikes at the Bank of England on Thursday and the U.S. Federal Reserve on Wednesday.
But like the BoE and the Fed, the ECB flagged even higher borrowing costs ahead to persuade investors it is still serious about fighting inflation, which could stay above the ECB’s 2 percent target through 2025.
“The Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2 percent medium-term target,” the ECB said.
The ECB also laid out plans to stop replacing maturing bonds from its 5 trillion euro ($5.31 trillion) portfolio, reversing years of asset purchases that have turned the central bank into the biggest creditor of many eurozone governments.
Under the plan, the ECB will reduce monthly reinvestments from its Asset Purchase Programme by 15 billion euros starting in March and revise the pace of balance-sheet reduction from July.
The move, which mops up liquidity from the financial system, is designed to let long-term borrowing costs rise and follows a similar step by the Fed earlier this year.
European shares extended losses and the euro gained against the pound and the yen after the ECB’s decision.
Questions
Lagarde is likely to face questions about how far the ECB intends to raise rates and reduce its bond holdings—and about the interplay between both.
But investors expecting substantive answers may be disappointed.
“A key difficulty is that the ECB does not know how high it will have to go, reflecting huge uncertainty about both transmission and the inflation outlook,” Greg Fuzesi, an economist at JPMorgan, said.
Thursday’s discussion is likely to have been heated after influential ECB board member Isabel Schnabel openly pushed back on the notion of smaller hikes advocated by chief economist Philip Lane.
Analysts saw scope for a compromise on the path for rates and the pace of the ECB’s unwinding of its bond portfolio, known as quantitative tightening (QT).
“Horse-trading remains the essence of ECB policymaking,” Davide Oneglia, an economist at consultancy TS Lombard.
“The counterpart of slower rate hikes will be hawkish guidance on the terminal rate ... accompanied by earlier or faster ‘passive’ QT.”
The eurozone’s economy has been holding up, with output growing more than expected in the third quarter, although a recession is widely expected.
Overall, the ECB was seen letting 175 billion euros ($186.01 billion) of debt expire next year, according to a Reuters poll, pointing to a 15-20 billion euro monthly reduction depending on the start date.
($1 = 0.9413 euros)
