ECB raises rates by 0.5 percentage points as Lagarde commits to ‘stay the course’

The European Central Bank raised interest rates by half a percentage point on Thursday and pledged to do the same in March, as its president Christine Lagarde warned that eurozone inflation remained “too high”.

The ECB decided to continue aggressive tightening after it raised its benchmark deposit rate to 2.5 percent, saying in a statement after its meeting that it would “remain on course”, raising rates “at a steady pace”. It confirmed that it intends another half-point hike to follow at its next monetary policy meeting, set for March 16.

“We know we have a base to protect, we know we’re not done yet,” Lagarde said at a press conference after the decision, adding that rate-setting already had enough evidence to be confident that further significant rate hikes would be necessary. “Inflation remains too high,” he said, adding that the disinflation process in the eurozone had not yet begun.

The bank’s commitment to push ahead with significant rate hikes sets it apart from its counterparts in the UK and US, which have signaled this week that interest rates are nearing their peak.

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The ECB’s move follows a half-point increase by the Bank of England earlier on Thursday and a quarter-point increase on Wednesday by the US Federal Reserve. However, the Fed has slowed the pace of tightening following signs that some price pressures in the US are fading, with chairman Jay Powell offering hope this week that inflation can return to the central bank’s 2 percent target without a “very significant economic slowdown”. The BoE also hinted that it may have reached a peak in interest rates at 4 percent.

The eurozone central bank has so far increased borrowing costs by 3 percentage points since it started raising rates – a smaller amount than the UK and US central banks.

The % line chart shows that the base interest rate has risen sharply

After March, the ECB said it would “assess the next path of its monetary policy”, which some market participants took as a dovish message, suggesting that interest rates may be nearing a peak.

The euro fell 0.89 percent against the dollar to $1.088 by midday, while in the fixed-income market, the yield on the 10-year German Bund, the regional benchmark, was down 0.2 percentage points to 2.09 percent. The yield on the equivalent Italian government bond fell 0.36 percentage points to 3.92 percent. Bond yields fall when prices rise.

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But Lagarde explained that, while the pace of rate hikes could slow from May onwards, it was unlikely the ECB would be ready to pause.

“The question is how much to hike further after March, not whether to hike further,” said James Rossiter, head of global macro strategy at TD Securities.

The decision is in line with the hawkish rhetoric adopted by Lagarde since December. Since then, the eurozone economy has proved more resilient than expected, helped by warmer weather and government support to help households and businesses cope with soaring energy bills.

While stronger growth is welcomed by policymakers, it will make it harder for them to tame underlying price pressures and return inflation to their 2 percent goal.

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Data published this week showed inflation rates fell more than expected, from 9.2 percent in the year to December to 8.5 percent last month. But euro zone core inflation – which excludes changes in food and energy prices, and is seen as a better indicator of longer-term price pressures – was unchanged at an all-time high of 5.2 percent.

Alongside the decision on interest rates, the ECB set out more details on its plan to start shrinking its balance sheet from next month by buying fewer bonds than the yield on maturing securities it owns.

It aims to reduce its portfolio by €15 billion a month from March to the end of June, with part of the reinvestment carried out broadly in line with current practice. As for corporate bond purchases, however, reinvestment will be “more strongly tilted towards issuers with better climate performance”, the ECB said.


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