European Central Bank hikes interest rates 75 basis points, signals more to come

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Bank of Canada hikes key interest rate to 3.25% — how will this impact you?
The Bank of Canada raised its benchmark interest rate three-quarters of a percentage point on Wednesday and signalled that the key rate “will need to rise further” to tackle high levels of inflation, hiking the cost of borrowing for Canadians, especially those who own their home. Anne Gaviola has more – Sep 7, 2022

The European Central Bank raised its key interest rates by an unprecedented 75 basis points on Thursday and signalled further hikes, prioritising the fight against inflation even as the bloc’s economy is heading for a likely winter recession.

With inflation at a half-century high and approaching double-digit territory, policymakers are worried that rapid price growth could become entrenched, eroding the value of household savings and setting off a wage-price spiral.

Following up on its July rate hike, the ECB raised its deposit rate to 0.75 per cent from zero and lifted its main refinancing rate to 1.25 per cent, their highest levels since 2011, with further moves anticipated in October and December.

Read more: Bank of Canada hikes key interest rate to 3.25% and says it’s not done yet

“We have more journey to cover going forward,” ECB President Christine Lagarde told a news conference, adding that there had been unanimous agreement among policymakers about the need for a 75-basis point hike to “frontload” the move towards rates consistent with bringing inflation to its two per cent mid-term target.

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Policymakers had for weeks oscillated between a 50 and a 75 basis-point increase, but another jump in both headline and underlying inflation appears to have settled the debate as figures indicate that price growth is now seeping into the broader economy, making it even harder to root out.

Indeed, the ECB raised its inflation projections once again, lifting the 2023 outlook to 5.5 per cent from 3.5 per cent and putting the 2024 rate at 2.3 per cent, above its 2 per cent target.

Markets were little surprised, however, as investors had already priced a more than 80 per cent likelihood of a 75 basis-point move, even if economists polled by Reuters were more evenly split, showing only a slight majority expecting the larger move.

With the ECB statement explicitly saying more rate hikes would be needed, markets continue to expect another 50 basis points at the ECB’s October meeting.

Click to play video: 'Another interest rate hike, but is it really helping lower inflation?'
Another interest rate hike, but is it really helping lower inflation?

Asked about the future direction and pace of rate changes, Lagarde said: “We didn’t say ‘raise at 75’ as if 75 is the norm – it is not.”

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Going into the meeting, conservatives feared that anything other than an outsized move would signal that the ECB was not serious about its inflation-fighting mandate — officially its sole objective.

That risked pushing up already high long-term inflation expectations, which would signal a loss of confidence in the ECB and raise questions about the bank’s inflation-targeting framework.

Timid action also risked weakening the euro and boosting inflation further through more expensive energy imports.

The euro has been languishing around parity against the dollar for weeks, not far from a two-decade low hit earlier this month.

That means more expensive exports of everything from oil to cars, which then raises prices for consumer.

Read more: Not all Canadians feel the pain of interest rate hikes. Here’s why that might change

Policymakers have also made the case for front-loading rate hikes partly to send a strong signal about the central bank’s inflation-fighting commitment and partly to get most of the hikes done before the onset of a recession becomes evident.

With high energy prices sapping purchasing power, a downturn is essentially inevitable. However, monetary policy is mostly powerless against a supply-shock driven downturn, firming the argument for hikes even if the economy suffers.

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Some policymakers are now openly talking about a recession, and the ECB’s new projections also show sharply lower growth in the coming years.

Still, a shallow recession may even be useful, some argued, as the bloc’s labour market is increasingly tight and a downturn could provide relief to firms now struggling to find workers.

The bank sees the euro zone economy expanding by 3.1 per cent this year and 0.9 per cent in 2023. While this year’s growth projection was lifted a touch, it was lowered sharply for 2023.

However Lagarde said its so-called “downside” scenario – involving a total shutdown of Russian gas supply and policies including energy rationing – would plunge the euro area into a recession next year, with a 0.9 per cent contraction foreseen.

Click to play video: 'What the Bank of Canada’s interest rate hike means for you'
What the Bank of Canada’s interest rate hike means for you

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