European Central Bank President Christine Lagarde said there will be more rate hikes ahead, but 75 basis point hikes will not be the norm.
On September 8, local time, the European Central Bank raised interest rates by 75 basis points, the same rate as the Fed raised interest rates more than a month ago.
Economists at Morgan Stanley and Nomura correctly predicted the decision, arguing that despite the worsening economic outlook, ECB President Christine Lagarde could not afford to A record 9.1% inflation rate. The worry is that failure to act now on price increases will leave inflation entrenched. This will make it harder to ease inflation later.
The ECB’s latest updated forecast shows inflation will average 8.1 percent this year and 5.5 percent in 2023, with its goal of keeping annual consumer price gains around 2 percent.
Meanwhile, forecasts for economic growth have been revised down. The ECB now expects growth to slow to 0.9% next year from 3.1% in 2022.
The euro fell against the dollar after Lagarde’s press conference, approaching a 20-year low of $0.9972. Lagarde said there would be more rate hikes ahead, but 75 basis point hikes would not be the norm.
With inflation rising this year, the ECB raised rates a few months later than the Fed. When it finally made its first move to raise borrowing costs in a decade in July, rates were raised by 50 basis points, ending the era of negative rates in one fell swoop.
Meanwhile, Fed Vice Chairman Lael Brainard said at a conference in New York on Wednesday that the central bank would keep monetary tightening “as long as inflation falls.” Brainard’s remarks came two weeks before a meeting of the Fed’s policymaking department. Economists expect the Fed to raise rates by another 75 basis points at its late September meeting.
Also on Wednesday, the Bank of Canada raised its main interest rate to 3.25%, the highest level in 14 years.
Unlike the Fed, the ECB has not announced any plans to begin reducing the 5 trillion euros ($5 trillion) of bonds it has bought since the financial crisis, known as quantitative easing (the central bank’s purchase of government bonds to lower long-term interest rates).
The hesitation in reversing quantitative easing stems from growing concerns about the disparate bond spreads between countries in the region. The ECB faces a unique problem among global central banks in that its decisions can significantly raise bond yields in some countries, but not others.
At the July meeting, Lagarde announced a special plan to help ease the spread problem by creating a transmission protection tool to ensure the impact of monetary policy changes is spread out smoothly and evenly across the euro zone. Whether the ECB will necessarily use this new tool remains to be seen.
Europe is bracing for a potential energy shortage this winter. Russia has indefinitely shut down vital gas pipelines to the European continent. While Russia said it was for repairs, European leaders said Russia was retaliating for sanctions that Europe imposed on Russia following the outbreak of the Russian-Ukrainian conflict in February.
The prospect of rising inflation and an energy crisis dimmed the outlook for the euro zone economy. The ECB is not predicting a recession, but Lagarde said that is a risk this winter.
Nomura expects the ECB to raise interest rates a few more times, raising the main deposit rate to 2% from the current 0%, before lowering it from September next year.