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European Central Bank Hikes Interest Rates Again as Inflation Persists

Key Takeaways

  • The European Central Bank raised its main interest rate to 4%, the 10th-straight increase. to put it at its highest ever level.
  • ECB projections showed inflation moving accelerating to 5.6% in 2023, higher than previous projections, amid increasing energy costs.
  • ECB President Christine Lagarde couldn’t forecast whether European interest rates had reached their peak.

The European Central Bank (ECB) raised its main interest rate for the 10th consecutive time, pointing to inflation projections that show prices remaining elevated into 2025. The 25 basis-point hike brings the ECB main deposit facility rate to 4%, the highest in the history of the institution, having raised rates from -0.5% in June 2022.

The ECB’s macroeconomic projections show average inflation at 5.6% in 2023 and 3.2% in 2024, higher than their previous forecasts, mainly due to higher energy prices. By 2025, the ECB now projections inflation to cool to 2.1%, almost at its 2% target rate.

Factoring in the impact of its rate hike, the ECB also lowered its projections for economic growth across Europe, now projecting it to expand by 0.7% in 2023, 1% in 2024 and 1.5% in 2025. In its June 2023 release, the ECB projected a 0.9% expansion of the European economy, followed by 1.5% growth in 2024 and 1.6% in 2025.

At a news conference, ECB president Christine Lagarde said she couldn’t say whether interest rates were at their peak level, suggesting further hikes could be warranted. The rate hike came as a surprise, with only 48% of economists anticipating the ECB action.

U.S. Federal Reserve Expected to Hold Rates Steady Next Week

While the U.S. appears set to keep interest rates at their current levels despite rising inflation, Europe is taking more action to tackle inflation that remains well above target levels. 

The rate hike comes ahead of next week’s Federal Reserve meetings, where it is widely expected that the central bank will pause its rate hike cycle on Sept. 20 at the current federal funds rate of 5.25% to 5.5%, its highest rate in 22 years. 

Both ECB and Fed officials have said interest rates may need to remain high until persistently high inflation is down to the 2% target level. After hitting a peak of 10.6% in October 2022, Euro area inflation cooled to 5.3% in August. In the U.S., inflation is down from 9.1% in July 2022, but the latest Consumer Price Index shows that prices have ticked back upwards after months of decline, hitting a 3.7% year-over-year increase in August, up from July’s 3.2% rate.

Markets have priced in a 97% probability that the Fed will hold its rates at its next meeting, according to the CME FedWatch tool. Future meetings are in doubt, as some Fed officials have said that while Federal Reserve rate increases need time to work, persistent inflation could force the Fed to raise rates again. After the September meeting, the Federal Reserve will issue its next interest rate decision on Nov. 1.