ECB slows rate hikes, but pledges continued inflation fight

THE European Central Bank raised interest rates for the fourth time in a row on Thursday (Dec 15), although by less than its last two meetings.

It also 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 eurozone raised the interest rate it pays on bank deposits from 1.5 per cent to 2 per cent 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 US 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 per cent target through 2025.

Later, at a press briefing, ECB President Christine Lagarde quashed investors expectations for a further slowdown of future rate hikes. “It is pretty much obvious that on the basis of the data that we have at the moment, we should expect to raise interest rates at a 50-basis-point pace for a period of time,” she said.

She added that keeping interest rates at restrictive levels will over time reduce inflation by dampening demand, and will also guard against the risk of a persistent upward shift in inflation expectations.

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“Most measures of longer-term inflation expectations currently stand at around 2%, although further above-target revisions to some indicators warrant continued monitoring.”

Lagarde noted that inflation risks “are primarily on the upside and in the near term, existing pipeline pressures could lead to stronger than expected rises in retail prices for energy and food. “

The ECB also laid out plans to stop replacing maturing bonds from its US$5.31 trillion portfolio, reversing years of asset purchases that have turned the central bank into the biggest creditor of many eurozone governments.

Under the plan, the ECB will reduce monthly reinvestments from its Asset Purchase Programme by 15 billion euros (S$21.6 billion) 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 .

“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 normalisation” 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 eurozone’s economy has been holding up, with output growing more than expected in the third quarter, although a recession is widely expected. REUTERS