Concerns over runaway inflation have mounted amid economic uncertainty in wake of Russia’s invasion of Ukraine.
The European Central Bank (ECB) has raised interest rates for the first time in 11 years. It joins several other central banks in prioritising concerns about runaway inflation – driven by, among other factors – Russia’s invasion of Ukraine – over fears of stifling growth.
The ECB raised its benchmark deposit rate by 50 basis points to 0 percent on Thursday, despite for weeks guiding markets to expect a 25 basis point increase. The bank, which encompasses the 19 countries that use the euro, also increased its main refinancing rate to 0.50 percent and promised possible further rate hikes as soon as its next meeting on September 8.
The bank said in a statement after its governing council held a meeting in the German city of Frankfurt that the larger-than-expected hike was justified by an “updated assessment of inflation risks”.
“Further normalisation of interest rates will be appropriate,” it added.
The bank is relatively late to the move, following similar actions by the United States Federal Reserve, which raised rates by 75 basis points in June.
The hike comes as recession predictions in the eurozone have increased for later this year and next year as soaring bills for electricity, fuel and gas have weakened businesses and individuals’ spending power. The economies of eurozone countries have been particularly exposed to the war in Ukraine given their widespread dependence on Russian oil and natural gas.
The concerns have helped push the euro to a 20-year low against the US dollar. After the move on Thursday, the euro gained more than 0.6 percent against the dollar, rising to above $1.02.
Balancing act
Raising borrowing rates is seen as the standard cure for excessive inflation, which is now running at 8.6 percent in the eurozone. But by making credit harder to get, rate increases can slow growth, creating a careful balancing act for central banks.
The goal for all central banks is to get inflation back down to acceptable levels – which for the ECB would be 2 percent annually – without tipping the economy into recession.
The ECB on Thursday also agreed to provide extra help to the currency bloc’s more indebted nations, approving a new bond purchase scheme called Transmission Protection Instrument (TPI), intended to cap the rise in their borrowing costs and limit financial fragmentation.
“The scale of TPI purchases depends on the severity of the risks facing policy transmission,” the ECB said in a statement. “The TPI will ensure that the monetary policy stance is transmitted smoothly across all euro area countries.”
As ECB rates rise, borrowing costs increase disproportionately for countries such as Italy, Spain and Portugal as investors demand a bigger premium to hold their debt.
The ECB’s commitment on Thursday comes as a political crisis in Italy is already weighing on markets following the resignation of Prime Minister Mario Draghi.
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