The European Central Bank had a clear message as it raised interest rates by a quarter of a percentage point on Thursday: It’s not done yet.
Even as the central bank, which sets interest rates for the 20 countries that use the euro, slowed down the pace of its monetary policy tightening, Christine Lagarde, the president of the bank, made plain that the fight against inflation was not complete.
“We are not pausing, that is very clear,” Ms. Lagarde told reporters in Frankfurt on Thursday. “We know we have more ground to cover.”
The quarter-point move is the smallest rise that policymakers have imposed since they started raising rates last summer, a campaign of seven consecutive increases, which has become the fastest pace of tightening in bank’s two-decade history. Thursday’s downshift came as the bank acknowledged the impact that past rate increases are now having across the eurozone.
But the insistence that the European Central Bank wasn’t ready to halt its rate-rising cycle follows speculation that other major central banks, particularly the Federal Reserve and Bank of England, are much closer to pausing rate increases. On Wednesday, the Federal Reserve raised rates by a quarter point, bringing them above 5 percent for the first time since mid-2007, while signaling that future increases were no longer a certainty.
In the eurozone, “the inflation outlook continues to be too high for too long,” Ms. Lagarde said on Thursday. “Headline inflation has declined over recent months, but underlying price pressures remain strong.”
Data published earlier this week showed that the inflation rate for the eurozone edged higher in April, with prices rising 7 percent from the year before. The annual inflation rate was 6.9 percent in March.
Still, within the inflation report were some signals that support a slowdown in policy tightening and analysts’ expectations that the central bank is nearing the end of this cycle of higher interest rates. The headline rate of inflation has dropped from its peak of 10.6 percent in October, and last month the core rate, which excludes energy and food prices, was slightly lower at 5.6 percent.
Policymakers are closely watching measures of so-called underlying inflation that signal how much inflationary pressure is being generated within the region’s economy, such as through wage growth or companies raising prices to maintain profit margins, as opposed to being imported in through higher energy costs.
“The fact that the E.C.B. again slowed down the pace of hikes suggests that the peak is not far away,” Holger Schmieding, an economist at Berenberg, wrote in a note. He predicted two more quarter-point increases.
Policymakers also highlighted the growing body of evidence that past rate increases are having an impact on financial conditions, justifying the smaller interest-rate move. Demand for loans dropped earlier this year and banks have substantially tightened the criteria they use to approve loans to households and businesses. Deteriorating lending conditions tend to lead to a slowdown in the economy, which would weaken inflation.
“The past rate increases are being transmitted forcefully to euro area financing and monetary conditions,” Ms. Lagarde said. It’s still uncertain how much that is then weighing on the economy beyond the banks, but she added that a “more marked slowing of bank lending” would lower price pressures more than expected.
The central bankstarted raising interest rates last July for the first time in a decade as energy prices soared and inflation climbed across the bloc. Since then, policymakers have increased rates by either half or three-quarters of a percentage point as they sought to quickly switch from the bank’s very accommodative policy stance in the wake of the coronavirus pandemic. The bank’s deposit rate, which is what banks receive for depositing money with the central bank overnight, was raised to 3.25 percent on Thursday, from minus 0.5 percent last July.
Even as inflation has peaked in the United States and Europe, policymakers have been careful to keep their options open about their next moves. Traders are betting that rate-increase cycles are nearly over, and some analysts have raised concerns that elevated rates could go too far and inflict unnecessary damage on economies around the globe. But policymakers have said they want to see firm evidence that domestic inflation pressures have moderated enough for inflation to return to their 2 percent targets.
“All governors are determined to fight inflation, tame inflation, and return it to 2 percent in the medium term,” Ms. Lagarde said.
She added that future decisions by the 26-person Governing Council would ensure that rates would be “brought to levels sufficiently restrictive” to return inflation to the target and “kept at those levels for as long as necessary.” But she offered no precise details of what would come next, instead emphasizing that each decision is made depending on the latest economic and financial data.
“This is a hiking journey that we are on,” she added.
When the European Central Bank last set policy rates, in mid March, financial markets were gripped by turmoil among banks, after two banks in the United States failed and giant Swiss lender Credit Suisse, under stress, was bought by its rival UBS.
At the time, Ms. Lagarde said that if the banking uncertainties faded, and the central bank’s outlook for inflation stayed the same, then policymakers would need to keep raising rates. Even though a third U.S. bank, First Republic, collapsed this week, banks in the eurozone have weathered the market turmoil leaving room for the central bank to keep raising interest rates.
The European Central Bank also said it expected to ramp up the shrinking of its bond holdings as it tightened its policy stance. From July, it will stop reinvesting the proceeds from maturing assets bought under its larger bond-buying program, which had about 3.2 trillion euros ($3.5 trillion) in assets at the end of April. In the past, bonds, mostly government debt, were purchased to encourage banks to do more lending and investments and generate more economic activity.
Source: New York Times
