In a pivotal moment, ECB President Christine Lagarde made a resolute gesture as she addressed the press conference following the governing council’s meeting on July 27, 2023, in Frankfurt, Germany.
The European Central Bank (ECB) sent shockwaves through the financial world on Thursday by announcing its 10th consecutive interest rate hike, prioritizing the battle against surging inflation over a weakening economy.
This relentless series of rate hikes has propelled the ECB’s main deposit facility from -0.5% in June 2022 to an unprecedented 4%. The driving force behind Thursday’s hike appeared to be the upward revisions in newly released staff macroeconomic projections for the Eurozone. These projections now anticipate inflation to average 5.6% this year, up from a previous forecast of 5.4%, and 3.2% next year, up from a previous estimate of 3%.
However, the ECB did slightly temper its closely monitored medium-term forecast, adjusting it from 2.2% to 2.1%.
In a market-moving statement, the ECB hinted that further rate hikes might be put on hold for the time being, stating, “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target. The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary.”
The Euro reacted swiftly to the announcement, plummeting by 0.5% against the U.S. dollar to reach $1.0686 at 3 p.m. Frankfurt time, marking a three-month low. In contrast, European stocks, which had been cautious in the morning, rallied, with the benchmark Stoxx 600 index climbing by 1.1%.
The ECB’s decision on Thursday also pushed up the interest rates on its primary refinancing operations and marginal lending facility by 25 basis points, reaching 4.5% and 4.75%, respectively.
Additionally, the ECB lowered its economic growth projections for the Eurozone, revising them from a 0.9% expansion in 2023 to 0.7%, from 1.5% in 2024 to 1%, and from 1.6% in 2025 to 1.5%.
While the ECB had previously indicated its next moves in prior meetings, economists and analysts were divided on whether the doves or hawks in Frankfurt would prevail at this September’s meeting. Money markets showed a roughly 63% chance of a rate hike by Thursday morning, up from a more even split in recent days.
Inflation concerns have been stoked by reports in the oil market, which suggest tighter supply and higher prices for the remainder of the year and beyond, coupled with signs of wage growth. A Reuters article on Wednesday, reporting the ECB’s expectation of Eurozone inflation remaining above 3% in 2024, appeared to increase market bets on a rate hike. The report came from a source ahead of the release of its projections on Thursday.
ECB President Christine Lagarde acknowledged the diversity of opinions within the Governing Council, stating, “Some members did not draw the same conclusion, and some governors would have preferred to pause and reserve future decisions once more certainty, more intelligence, would have resulted from the passing of time and the impact of our many previous decisions.” Nevertheless, Lagarde emphasized that a solid majority of governors supported the decision made.
As for whether rate hikes are now concluded, Lagarde emphasized that the Governing Council remains data-dependent but stressed that the current stance, as articulated in the statement, would make a “substantial contribution” to the fight against inflation if sustained over an extended period.
In parallel developments, Germany, the bloc’s headline consumer price inflation, stood at 5.3% in August, matching core inflation, which excludes food and energy costs. Germany’s economic outlook remains bleak, with deteriorating business sentiment and declining services and manufacturing sectors. It is projected to be the only major European economy contracting this year. The broader Eurozone is also grappling with negative economic indicators, with business activity in August sinking to its lowest level since November 2020.
Peter Schaffrik, Chief European Macro Strategist at RBC Capital Markets, emphasized that market attention will not solely be on the rate hike but also on the language used by the central bank in its statement. He highlighted the importance of the 2025 inflation forecast, which was revised lower, and the indication that rates would be maintained at current levels for a “sufficiently long duration,” suggesting a “flat” path forward for quite some time.
