European Central Bank Follows The Fed, Raising Rates 75 Basis Points

The European Central Bank’s (ECB’s) Governing Council has increased interest rates by 75 basis points. This makes the ECB somewhat late to the group of central banks including the Fed, which may make a similar 75bps move later in September, raising interest rates aggressively to combat inflation. There are likely more ECB hikes to come.

Alignment With Other Central Banks

Nonetheless, the message from the ECB is now similar to that of other major Western nations concerned about high inflation. Eurozone rates may ‘catch up’ with other central banks in 2023 if they remain on this hawkish path for interest rates.

It is interesting that the ECB has been slower to raise rates than the U.S., since arguably the European inflation outlook is worse given the bleak outlook for European energy markets.

An End To Negative Rates

Symbolically, this moves brings an end, at least for now, to negative interest rates for the Eurozone, and so the special measures associated with that are now withdrawn.

Asset Purchases

However, another major initiative the ECB’s major asset purchases remain in place as the ECB continues to reinvest principle under the APP and PEPP initiatives until at least 2024, on current guidance. That’s important because although the markets will not enjoy higher interest rates, the ECB selling down major asset holdings has the potential to further hurt fixed income markets.

Further Rate Hikes Expected

The ECB was clear that more interest rate hikes are very likely coming as the press release stated. “Over the next several meetings the Governing Council expects to raise interest rates further.” This is because inflation is “too high” in the ECB’s view running at over 9% in the Eurozone for August.

Inflation Well Ahead Of Target

The ECB also does not expect inflation to fall back to its target of 2% especially rapidly with their updated forecasts showing over 8% inflation for 2022 as a whole, and over 5% for 2023. Some may view those forecasts as optimistic. Early in this bout of inflation there was discussion of how inflation may prove transitory, but now support for that view has faded.

Recession Risk

The ECB is also not optimistic on the Eurozone economy. They are concerned that very high energy prices are eating into consumer’s budgets. They see the Eurozone growing just above zero in 2023, creating a clear risk that the economy falls into recession. Like other central banks, they see the need to bring down inflation, as is their mandate, but realize that doing so may also slow economic growth.

The Euro

The other question is for the currency markets. Part of the ECB’s role, in addition, to managing inflation, is to protect the value of the Eurozone’s currency. The Euro has weakened in 2022, now standing at parity with the dollar. The Euro is flirting with some of the lowest levels seen against the dollar two decades, though the dollar is currently strong against many currencies not only the Euro. The rise in interest rates may help the Euro, but either higher interest rates or a strong economic performance from the Eurozone relative to the U.S. will likely be needed to get the Euro back on track.

Future Plans

So the question now is how much the ECB will raise rates until they are satisfied inflation is under control. If the actions from other central banks are any guide, we could see several more large hikes from the ECB until they have confidence that their job in taming inflation is done.