European Central Bank hikes interest rates again while US Fed pauses

The European Central Bank (ECB) has raised interest rates a further 25 basis points. Despite acknowledging that inflation has been coming down, it projected inflation is expected to remain too high for too long.

The decision to hike interest rates is in contrast with the US Federal Reserve’s decision on Wednesday (yesterday) to pause further rate hikes for the first time in over a year, in order to assess their impact so far. The current US Federal Reserve benchmark rate is 5-5.25 per cent.

The ECB’s new interest rates are set to come into effect on from 21st June.

It will result in the deposit facility interest rate rising to 3.5 per cent and marginal lending to 4.25 per cent. Refinancing operations will see an increase to four per cent.

According to the June macroeconomic projections, Eurosystem staff expect headline inflation to average 5.4 per cent in 2023, three per cent in 2024 and 2.2 per cent in 2025.

Their projections indicate that underlying price pressures are to remain strong, although some show tentative signs of softening. Nevertheless, staff have revised up their projections for core inflation owing to past upward surprises and implications of the robust labour market.

Following the eurozone’s slight dip into a recession, ECB staff have lowered their economic growth projections for the current and following year, and expect the economy to grow by 0.9 per cent in 2023, 1.5 per cent in 2024 and 1.6 per cent in 2025.

The ECB noted that past interest rate increases are being transmitted forcefully to financing conditions and are having an impact across the economy.

“Borrowing costs have increased steeply and growth in loans is slowing. Tighter financing conditions are a key reason why inflation is projected to decline further towards target, as they are expected to increasingly dampen demand.”

It reiterated that the Governing Council’s future decisions will ensure that key ECB interest rates will be brought to sufficiently restrictive levels in order to achieve a timely return of inflation to the two per cent medium-term target and will be maintained at those levels “for as long as necessary.”