FRANKFURT — The European Central Bank raised interest rates for the fourth time in a row on Thursday, although by less than at its last two meetings, pledged further hikes and laid out plans to drain cash from the financial system as part of its fight against runaway inflation.
The ECB has been raising rates at an unprecedented pace to rein in prices that have soared since economies reopened after the COVID-19 pandemic, driven by supply bottlenecks and then surging energy costs following Russia’s invasion of Ukraine.
The central bank for the 19-country euro zone raised the interest rate it pays on bank deposits from 1.5% to 2% on Thursday, moving further away from a decade of ultra-easy policy after being wrong-footed by the sudden rise in prices.
The decision marked a slowdown in the pace of tightening from 75-basis-point hikes at each of the ECB’s two previous meetings, as inflation shows signs of peaking and a recession looms.
The decision was in line with economists’ expectations and mirrored similar rate hikes at the Bank of England on Thursday and the U.S. Federal Reserve on Wednesday.
But like the BoE and the Fed, the ECB flagged even higher borrowing costs ahead to persuade investors it is still serious about fighting inflation, which could stay above the ECB’s 2% target through 2025.
The ECB gave a strong hint that future hikes will also be worth 50 basis points, quashing investors expectations for a further slowdown, and borrowing costs would remain “restrictive” – economic parlance for financing conditions that curb growth -for long.
“The Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target,” the ECB said.
The ECB also laid out plans to stop replacing maturing bonds from its 5 trillion euro ($5.31 trillion) portfolio, reversing years of asset purchases that have turned the central bank into the biggest creditor of many euro zone governments.
Under the plan, the ECB will reduce monthly reinvestments from its Asset Purchase Programme by 15 billion euros starting in March and revise the pace of balance-sheet reduction from July.
The move, which mops up liquidity from the financial system, is designed to let long-term borrowing costs rise and follows a similar step by the Fed earlier this year.
European shares extended losses and the euro gained against the pound and the yen after the ECB’s decision .
ECB President Christine Lagarde will hold a news conference at 1345 GMT.
Lagarde is likely to face questions about how far the ECB intends to raise rates and reduce its bond holdings – and about the interplay between both.
But investors expecting substantive answers may be disappointed.
“A key difficulty is that the ECB does not know how high it will have to go, reflecting huge uncertainty about both transmission and the inflation outlook,” Greg Fuzesi, an economist at JPMorgan, said.
The ECB did say, however, that it will update the market on the “the endpoint of the balance sheet normalization” by the end of 2023, indicating by how much it plans to reduce liquidity in the banking sector.
This is crucial for determining the cost of funding for banks and therefore the interest rates applied to companies and households.
Thursday’s discussion is likely to have been heated after influential ECB board member Isabel Schnabel openly pushed back on the notion of smaller hikes advocated by chief economist Philip Lane.
The euro zone’s economy has been holding up, with output growing more than expected in the third quarter, although a recession is widely expected. ($1 = 0.9413 euros)
(Editing by Tomasz Janowski and Catherine Evans)
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