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On 14 September, the European Central Bank (ECB) raised its key interest rate for the 10th time in as many meetings, bumping it by a quarter point to an even 4 percent, the highest since the euro currency was introduced in 1999.
It was a split decision; some officials pressed for a pause in rate hikes, the Financial Times reported. They cited slowing wage growth, weakness in bank lending, softening inflation, and the region’s general economic fragility.
After raising the rate anyway, the bank’s governing council indicated that it might be done lifting its rate. The euro’s value sank on the news.
The rate has “reached levels that, maintained for a sufficiently long duration, will make a substantial contribution” to inflation reaching the bank’s 2-percent target, ECB president Christine Lagarde said in a press briefing.
The euro’s value then tumbled down below $1.07 to its lowest since March. Stocks rallied but yields on government bonds in France, Germany, and Italy sank. The euro closed at $1.07 on 18 September.
If the ECB holds its rate below that of the U.S. Federal Reserve, dollar-based assets become more attractive and could be expected to suck investments away from Eurozone countries.
Also, Europe’s inflation rate is higher and its economy weaker than those of the U.S.
The ECB’s key rate was -0.5 percent in July 2022. Banks had to pay the ECB to store money there, giving them an incentive to lend the money out.
That poured more cash into the Eurozone economy, helping to drive inflation to a record 10.7 percent last October.
The bank’s latest rate increase follows a report by its analysts raising this year’s expected full-year inflation rate from 5.4 percent to 5.6 and next year’s from 3 percent to 3.2.
The ECB also pared back its forecast for the Eurozone’s economic growth this year from 0.9 percent to 0.7 and reduced its outlook for next year’s expansion from 1.5 percent to 1 percent.
The bank’s leaders did not rule out future rate increases. The ECB’s “governing council is determined to ensure that inflation returns to its 2-percent medium-term target in a timely manner,” the group said in a statement.
The governing council “can’t say we’re at peak,” Lagarde cautioned.
The U.S. Fed also has indicated it is likely near, or possibly at, the end of its rate-raising campaign.
Investors are betting that rates have peaked and that the Fed will begin cutting its base rates as soon as early 2024 as inflation and economic growth both cool, The Wall Street Journal reported. Markets are expecting the ECB to keep its rate around 4 percent at least until fall 2024.
Analysts and investors expect the Bank of England to increase its rate at least once more this year and not to reduce it until at least late in 2024, the WSJ said.
TREND FORECAST: As we noted in “ECB Boosts Interest Rate to 23-Year High” (1 Aug 2023), the war in Ukraine will continue to chip away at Europe’s economy, denying it foods, raw materials for manufacturing, and finished parts for factories, all while keeping upward pressure on prices. Now, with oil nearing $100 a barrel, Europe’s energy security this winter falls into doubt.
Because of that combination of negative factors, inflation across Europe will worsen and, under the load of an even higher interest rate, slow even more toward recession.
Europe’s economic security will remain in doubt until the Ukraine War ends.
And as we note in our ECONOMIC UPDATE in this issue, the high interest rates will bring much of Europe into Dragflation: Declining economic growth and rising inflation.