ECB President Christine Lagarde is acting aggressively to fight inflation as prospects for growth get worse.
POOL/AFP via Getty ImagesThe European Central Bank produced an oversized interest-rate hike on Thursday as it tries to keep pace the Federal Reserve.
The ECB lifted rates by 0.75 point, the same size delivered by the Fed a little more than a month ago.
Economists at Morgan Stanley and Nomura , who correctly predicted the decision, argue that inflation at a record rate of 9.1% is unbearable for ECB President Christine Lagarde, despite the outlook for the economy deteriorating. The concern is that failing to act against price gains now would allow them to become entrenched. This would make bringing inflation down later much harder.
The central bank updated its forecasts to show inflation averaging 8.1% this year and 5.5% in 2023. The target is to keep annual consumer price gains at around 2%.
At the same time, predictions for growth were downgraded. The ECB now sees economic expansion slowing to 0.9% next year from 3.1% in 2022.
The euro fell after the decision, trading close to a 20-year low against the dollar at $0.9972 as Lagarde held a press conference. She said that there will be more interest-rate hikes to come, but that 0.75-point moves wouldn’t be the norm.
The ECB raised interest rates several months later than the Fed as inflation rates picked up this year. When it finally lifted borrowing costs for the first time in a decade in July, it moved by a half point, ending an era of negative interest rates at a stroke.
Meanwhile, the Federal Reserve’s vice chair said at a conference in New York on Wednesday that the central bank would keep money tight “for as long as it takes to get inflation down.” Lael Brainard’s speech comes two weeks before the Fed’s policy-making arm meets. Economists expect another interest rate increase, possibly another three-quarter point .
Also on Wednesday, the Bank of Canada raised its main interest rate to 3.25%, its highest level in 14 years.
Unlike the Fed, the ECB has yet to announce any plans to start reducing the €5 trillion ($5 trillion) in bonds it has acquired since the financial crisis. That action of central banks buying government bonds will the aim of reducing longer-term interest rates is known as quantitative easing.
The hesitance to reverse QE comes out of concern that reducing that pile would exacerbate differing bond spreads between countries in the region. The ECB faces a unique problem among global central banks in that its decisions can increase bond yields dramatically more in some countries than others.
Lagarde announced a special program to help mitigate the problem of rate spreads with the July decision. The Transmission Protection Instrument is now set up to make sure the impact of changes in monetary policy are distributed smoothly and evenly across the euro area. It remains to be seen if the ECB will have to use this new tool .
Europe is bracing for potential energy shortages this winter. Russia has indefinitely closed a key natural gas pipeline to the continent. While it says this is for repairs, European leaders say Russia is retaliating for sanctions levied against it after it invaded Ukraine in February.
Faster inflation and the prospect of an energy crisis have darkened the outlook for the euro region economy. The ECB isn’t predicting a recession, but Lagarde said it is a risk over the winter.
Nomura nevertheless expects a few more rate hikes from the ECB to bring the key deposit rate up to 2% from the current 0%. It then expects the central bank to start bringing the rate back down in September next year.
Write to brian.swint@dowjones.com
