The European Central Bank has raised interest rates by half a percentage point, slowing the pace of tightening in line with policymakers in the US and UK, while warning investors to expect a repeat of similar-sized moves in the coming months.
ECB president Christine Lagarde pushed back against market expectations of an early end to rate rises next year by saying in a press conference on Thursday it had “more ground to cover, we have longer to go” to tame inflation than the US Federal Reserve.
“The ECB is not pivoting,” she said, promising at least two more 0.5 percentage point rate increases in February and March.
Investors viewed the remarks as hawkish, sending governments’ borrowing costs sharply higher and raising their bet for where the ECB deposit rate will peak from 2.9 per cent to just over 3 per cent.
The price of the benchmark 10-year German government bond fell sharply as its yield rose by 0.27 percentage points to 2.4 per cent, the highest level since 2008.
Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said the ECB’s communication was “very, very hawkish”.
The ECB raised its deposit rate from 1.5 per cent to 2 per cent with immediate effect and announced plans to start shrinking the €5tn-worth of bonds it has acquired over the past eight years from March.
It warned inflation would remain above its 2 per cent target even in three years’ time, which meant it had to keep raising rates significantly to squeeze economic growth. “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,” it said in a statement.
Lagarde said it was “pretty much obvious that on the basis of the data we have at the moment” rate-setters expected “to raise interest rates at a 50 basis-point pace for a period of time”.
She added: “We have made progress over the past few months but we have more ground to cover, we have further to go.”
Vitor Constâncio, former ECB vice-president, criticised the decision, writing on Twitter that it indicated “an excessively hawkish policy that will aggravate the coming recession unnecessarily”.
The decision comes after the US Federal Reserve, the Bank of England and the Swiss National Bank all raised rates by half a point this week, down from previous 0.75-point moves. In its previous two rate-setting meetings, the ECB raised borrowing costs by 0.75 percentage points each time.
By lifting rates in smaller increments, central banks on both sides of the Atlantic are responding to signs that inflation has peaked in many countries. The US and European economies appear increasingly likely to slide into recession in the coming months.
The ECB has now increased interest rates at each of its past four meetings by a total of 2.5 percentage points, its most aggressive set of rises since the euro was created in 1999.
Eurozone inflation fell from a record high of 10.6 per cent in October to 10 per cent in November. However, the bank on Thursday lifted its inflation forecast for this year to 8.4 per cent, 6.3 per cent next year and 3.4 per cent in 2024. It said inflation would be 2.3 per cent in 2025, implying that tighter credit conditions were needed to bring inflation down to target.
Lagarde said the higher estimates were based on the view that food and energy prices would rise by more than expected in the coming months.
Ducrozet described the fresh inflation forecasts as a “shocker”, while Constâncio labelled them “controversial”.
The central bank on Thursday said it would start shrinking its bond portfolio by €15bn a month through a partial reduction of the amount of maturing bonds it replaces with new purchases from next March. It will review the pace of the operation in the summer.
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