The European Central Bank eased the pace of its interest rate hikes on Thursday but stressed significant tightening remained ahead and laid out plans to drain cash from the financial system as part of a dogged fight against runaway inflation.
After being wrong-footed by sudden price rises, the ECB has been raising rates at an unprecedented pace. Inflation has soared since economies reopened after the COVID-19 pandemic, driven by supply bottlenecks and then surging energy costs following Russia’s invasion of Ukraine.
In a move shadowing similar steps this week by the Federal Reserve and Bank of England, it raised the rate it pays on bank deposits by 50 basis points to 2%, moving further away from a decade of ultra-easy policy. read more
That decision, which was expected, marked a slowdown in the pace of tightening from 75-basis-point hikes at each of the ECB’s two previous meetings, as price pressures show some signs of peaking and a recession looms.
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 according to its new forecasts could stay above the ECB’s 2% target through 2025.
“We judge that interest rates will still have to rise significantly and at a steady pace,” ECB President Christine Lagarde told a news conference, saying further 50-basis-point rises should be expected for “a considerable amount of time”.
“We will sustain the course – it will not be enough to hit and withdraw.”
Lagarde said inflation risks were still skewed to the upside, citing the possibility of a bout of higher-than-expected wage growth and of government support measures that ended up boosting demand across the 19-member euro zone economy.
The ECB statement said it currently expected any recession to be “relatively short-lived and shallow” and Lagarde noted that euro unemployment levels were at “rock-bottom”.
The hawkish tone of the statement and Lagarde’s news conference comments pushed the euro above $1.07 to its highest level for nearly half a year.
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 euro zone governments.
Under the plan, it 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.
The ECB said it would update the market on the “the endpoint of the balance sheet normalisation” by end-2023, indicating by how much it plans to reduce liquidity in the banking sector.
This is key for determining the cost of funding for banks and therefore the interest rates for companies and households.
The euro zone’s economy has been holding up, with output growing more than expected in the third quarter, although a recession is widely expected.
($1 = 0.9413 euros)