The European Central Bank (ECB) plans to raise interest rates next month for the first time since 2011 after warning that inflation would rise more than expected.
Resisting calls for a 0.5% hike next month, the ECB’s governing council said the base rate for the 19-member currency bloc would be raised by 0.25% with a further hike, and possibly be larger, scheduled for September.
The July hike will raise the main commercial bank deposit rate by -0.5% and raise the lending rate from 0% to the equivalent Bank of England base rate of 1%.
Monthly injections of electronic funds into the economy, known as quantitative easing, will also be stopped in July, although the existing stock of ECB loans will remain at around £8bn, or 63% of the annual gross domestic product of the euro area.
At a meeting in Amsterdam, the board of governors said inflation had become a “major challenge” and inflationary forces had “widened and intensified”.
According to its latest forecast, inflation would average 6.8% this year, well above the 5.1% forecast in March, before falling back to 3.5% in 2023 and 2.1% in 2024.
Officials said they feared Russia’s invasion of Ukraine had hit “confidence, consumption and investment”, leaving the euro zone with weaker growth prospects.
“This is disrupting trade, causing material shortages and contributing to higher energy and raw material prices. These factors will continue to weigh on confidence and dampen growth, especially in the short term,” the ECB said.
However, the invasion was unlikely to push the eurozone into recession, he said, adding: “The conditions are in place for the economy to continue to grow due to the ongoing reopening of the euro zone. economy, a strong labor market, [government] support and savings accumulated during the pandemic.
Inflation in the euro zone reached over 8% last month and could peak in the third quarter before a slow decline expected by the ECB.
Skyrocketing energy prices have been blamed for the bulk of the surge in inflation. Food prices also rose rapidly while underlying price growth, which filters out volatile food and fuel prices, was well above 2%.
Hetal Mehta, senior European economist at Legal & General Investment Management, said there was a high risk that the euro zone could slide into recession next year.
She said Italy would be most vulnerable to higher interest rates after its debt-to-GDP ratio rose to 160% during the pandemic.
“The European Central Bank is in a difficult position, with extremely high inflation, slowing growth and a tight labor market. We now see a recession risk in the eurozone as high as 60% for the second half of 2023,” Metha said.
“Rising ECB interest rates and Italy’s borrowing costs call into question Italy’s debt sustainability. As a result, the ECB will need to be more “predictable” in raising interest rates, far more than we have seen from other central banks such as the Federal Reserve or the Bank of England.