European Central Bank Raises Rates by a Half Percent, Vows Another Large Increase in March

European Central Bank President Christine Lagarde, in Brussels, on Nov. 28, 2022. Johanna Geron/Reuters

The European Central Bank raised interest rates for the fifth consecutive time at its first meeting this year.

The hawkish move in Europe is in contrast to the U.S. Federal Reserve, which slowed down its benchmark policy rate increase on Feb. 1, with a quarter-point hike.

Central bank policymakers in Frankfurt vowed to continuing hiking policy rates by another 50 basis points on Feb. 2, with a similar increase for March, while some of their peers slowed down their pace worldwide.

As inflation increased across the eurozone, the ECB rapidly raised its benchmark rate to 3 percent over the last seven months, as it was one of the last major central banks to act on the crisis last year.

The Fed’s federal funds rate after yesterday’s meeting is in the range of 4.50–4.75 percent.

The ECB’s move is partially explained by its late start, when it began raising rates in July, four months after the Fed made its first increase, but beginning at lower levels, which has forced it to catch up.

ECB Maintains Hawkish Rate Policy

“The Governing Council will stay the course in raising interest rates significantly at a steady pace,” the ECB said in a statement.

Policymakers said they intend “to raise interest rates by another 50 basis points at its next monetary policy meeting in March, and it will then evaluate the subsequent path of its monetary policy.”

The ECB is maintaining an aggressive stance to combat the spike in prices, which have since slowed from record highs in 2022, but continue to hurt households in the eurozone.

ECB president Christine Lagarde said at a news conference that they “will stay the course in raising interest rates significantly at a steady pace.”

“Now you will say, ‘Well, yes, but what about after March? Does that mean that you have reached the pinnacle or the peak?' she later added.

“No, no, no, no. We know that we have ground to cover. We know that we are not done.”

Central Bank Policymakers Debate Inflation Control Policy

Underlying inflation throughout much of the West remains stuck at highest level in decades, while wage growth, a key component of long-term inflation, continues to accelerate in a tight labor market.

The unemployment claims rate also remains at an all-time low.

Officials hope that higher borrowing rates will slow consumer demand and keep high price growth from becoming a long-standing factor.

Markets were still pricing in another full percentage point rate hike after the ECB’s move, reported Reuters, putting the deposit rate at its highest in over two decades.

The ECB lifted its deposit rate to 2.5 percent from 2 percent, which it said it would do in December, while the Bank of England maintained its hawkish policy on Feb. 2 with a similar half-point hike.

Meanwhile, central banks around the world, led by the Fed, are beginning to reassess their approach to controlling inflation as prices started to slow.

The move by U.S. central bank on Feb. 1 had clearly signaled a slowdown trend in the pace of policy tightening, suggesting that the ECB’s window of opportunity may start to close sooner than expected.

Policymakers worldwide have become increasingly split over future borrowing rate policies in recent weeks, as the latest inflation data remain ambiguous and either supports the case of both raising or slowing rate hikes.

Many investors have gone along with hawkish policies for now, but some are beginning to worry.

Policy doves claim that headline inflation is already two percentage points below its peak, which may point to a further drop in inflation.

Lagarde noted a rapid decline in natural gas prices in recent weeks, despite a ban on Russian gas imports, as a positive sign.

“The economy has proved more resilient than expected and should recover over the coming quarters,” she said.

Fears of Recession Loom in Europe

Meanwhile, the eurozone remains on the brink of recession, as credit growth may see its biggest drop since the bloc’s last major debt crisis in 2011, suggesting that rate hikes are slowly having the effect the economy of European Union.

However, higher interest rates restrict economic growth if they go up too far, as the eurozone economy has stagnated down to 0.1 percent growth in the last three months of 2022.

Lagarde acknowledged that “economic activity has slowed markedly” since the middle of last year and is expected to remain weak, as global consumer demand slows and the Russian war in Ukraine continues to raise concerns.

Raising borrowing rates makes it more expensive for consumers to make large purchases like homes and cars, or allow companies to fund expansions.

Consumer prices, which increased to 8.5 percent in the eurozone last month from a year earlier, while still historically elevated, has dropped three months in a row after reaching a record high of 10.6 percent in October.

This is well above the ECB’s inflation target of 2 percent.

Energy Shortages Continue to Plague the Continent

High energy prices, which are the main driver of inflation in Europe, has been led by shortages caused by anti-Russian sanctions over Ukraine.

So far, governments in the European Union and the United Kingdom have passed billions euros and pounds in relief to alleviate financial pressure from high natural gas prices, which have driven up energy costs for millions of households, trickling down to food and retail prices.

Business and industry have suffered, as rising energy costs cut into operational expenses, especially in Germany, Europe’s largest economy.

Energy prices have slightly fallen from an all-time high last summer, after countries in the bloc were able to find alternative suppliers and due to a mild winter, which reduced shortages and rationing, but prices remain three times higher than they were in the same period a year ago.

“It is important to now start rolling these measures back promptly in line with the fall in energy prices and in a concerted manner,” Lagarde said.

Over the past few months, labor unions throughout Europe have been holding strikes and demanding that their pay keep pace with the rising cost of living, while other civilians are protesting the EU’s stance on Russia, blaming the sanctions for worsening living standards.

Reuters and the Associated Press contributed to this report.