Higher for longer: ECB hikes rate by 25bp

Autor: Tiberiu Porojan
3 min

Fears of not fully controlling inflation and the risk of stopping too soon must have surpassed concerns about the rising risk of recession in the euro area.

This motivated the European Central Bank to raise interest rates for the tenth consecutive time since July 2022. After a total of 450 basis point rate hikes, the ECB’s deposit rate is now at a record level.

The ECB’s staff projections indicate too high inflation and lower growth. The ECB remains very concerned about inflation, not just the current inflation but also future inflation.

The latest ECB staff forecasts show that total inflation will reach 3.2% in 2024 and 2.1% in 2025. However, the upward revision for 2024 is mainly the result of rising energy prices.

The inflation forecast for 2025 was revised downwards. The ECB’s core inflation projections were slightly revised downwards to 2.9% in 2024 and 2.2% in 2025.

Yet, in the ECB’s eyes, both general and core inflation above 2% in 2025 are not in line with its own definition of price stability.

It was not so much the direction of revisions but rather the absolute levels and the prolonged deviation from the target that motivated today’s ECB decision.

The ECB’s GDP growth projections for the Eurozone were also revised downwards to 0.7% in 2023, 1.0% in 2024, and 1.5% in 2025.

However, the downward revision for 2024 is merely the result of carry-over effects and the quarterly profile for 2024 remains unchanged, pointing to a return to potential growth starting from the second quarter of 2024.

The ECB continues to hold onto the view of a temporary slowdown and not a more significant structural growth weakness.

A dovish rate hike as a compromise

The staff projections probably intensified the ECB’s dilemma: inflation, although declining, remains too high, but growth prospects continue to deteriorate.

Given this macro backdrop, both a rate hike and a pause would have been plausible. This time, the ECB decided on a compromise: a measured hike, mainly to reinforce credibility and probably to bridge the growing gap between the ECB’s hawks and doves.

In this respect, a remark from the official communication is essential: „Based on its current assessment, the Governing Council believes that the ECB’s key interest rates have reached levels that, if maintained for a sufficiently long duration, will make a significant contribution to bringing inflation back to target.

Considering the inaccuracy of the ECB’s own models in recent years, it’s doubtful how the ECB now concludes that the current level is sufficient. Why not 25 basis points less? Why not 25 basis points more?

During the press conference, ECB President Christine Lagarde alluded to different views within the Governing Council. According to Lagarde, today’s decision was made with a „solid” majority. A measured hike as a compromise for balancing credibility, inflation, growth, and team spirit.

The final hike?

Looking forward, the ECB would be foolish to completely rule out further interest rate hikes. Inflation has simply taken too many unexpected twists, and the ECB has been wrong too often in the past.

This is why today’s meeting still leaves the possibility of resuming the hiking journey at a later stage. However, such a scenario is highly unlikely. A further weakening of the economy and gaining traction in a deflationary trend will make it very difficult to find arguments for further rate hikes anytime soon.

For now, the ECB is determined to keep rates where they are currently, waiting for the total of 450 basis point rate hikes to filter through the economy. The next discussion will be about how long the new „percentage for a longer time” can be sustained.

Even if the door to future interest rate hikes remains open, today’s rate hike will soon be remembered as the last hike in the most aggressive rate hike cycle in ECB history.”