European Central Bank announces largest interest rate hike in bid to fight inflation

The European Central Bank on Thursday announced a record rate hike in a bid to stifle record inflation across the euro area.

The ECB’s three key interest rates were each raised by 75 basis points.

“This major step frontloads the transition from the prevailing highly accommodative level of policy rates towards levels that will ensure the timely return of inflation to the ECB’s 2% medium-term target,” the bank’s Governing Body said in a statement.

It also flagged to markets that “over the next several meetings the Governing Council expects to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations.”

The move sees the ECB follow in the policy footstep of the US Federal Reserve which carried out two jumbo rate hikes of 0.75 points in June and July. 

It also comes just over a month after the ECB operated its first increase in 11 years by a larger-than-expected 0.5%.

Central banks’ main mandate is to keep inflation under control and one of the main tools at their disposal is interest rates through which they can make the cost of borrowing — and therefore spending and investing — either cheaper or more expensive as it becomes more or less costlier for commercial banks to borrow money.

There is a risk however that a hike in interest rates could also lead to slower growth as consumers and businesses delay spending. 

Inflation across the 19 countries of the eurozone reached a record 9.1% last month led by a surge in energy, and in particular gas, prices.

The Frankfurt institution, which tries to keep inflation at around 2%, now expects inflation to average 8.1% this year before starting a slow decrease and settle at 5.5% in 2023 and 2.3% in 2024.

It meanwhile expects economic growth to take a hit and reach 3.1% in 2022, 0.9% next year and 1.9% the following year.

The “substantial slowdown” is attributed to “very high energy prices” which are impacting purchasing power at a time when supply chain disruptions, although easing, are still “constraining economic activity.”

“In addition, the adverse geopolitical situation, especially Russia’s unjustified aggression towards Ukraine, is weighing on the confidence of businesses and consumers,” the ECB said in its statement.