ECB raises rates by 0.75% and promises further hikes

The European Central Bank (ECB) hiked interest rates by 75 basis points on Thursday, October 27. A further monetary tightening is foreseen, along with a subsequent slowdown in economic growth. 

The benchmark rate in the Eurozone is expected to reach 1.5%. However, rate hikes took place at the three previous meetings of the ECB. In total, the indicator rose by 2%. The key objective was to curb inflation despite the impending recession in European countries. 

As the central bank says, inflation is still high, with the 2% level being the target. In recent months, skyrocketing prices for energy and food, as well as supply disruptions and demand recovery after the pandemic, have led to rising price pressures and soaring inflation. 

The annual inflation rate in Europe hit a historic 9.9% in September.

A rapid inflation surge in the Eurozone surprised policymakers, Christine Lagarde, the ECB chairman, noted. On the other hand, higher energy costs could lead to soaring inflation in the medium-term outlook. 

With growing prices, the European Union is also facing a weakening economy due to the slowdown. This makes it difficult for the central bank to function, as rising interest rates often reduce demand, making borrowings more expensive. 

The energy crisis has affected the manufacturing sector. In addition, the cost of living crisis caused a fall in spending on goods and services. 

The ECB head mentioned the risks to economic growth perspectives are constantly increasing. Thus, the level of economic activity has already fallen dramatically in the third quarter of 2022. Further weakening is forecasted in the fourth quarter, as well as early next year. 

According to Lagarde, European banks would tighten credit standards on loans. This is due to the greater risks faced by their customers in the current environment.

Despite a poor economic outlook, the ECB is set to continue raising interest rates in the Eurozone. The ultimate goal for the medium term will be inflation of 2%. The rate should be hiked until the central bank hits its objective. Ensuring price stability in the EU will also come to the forefront in the planned course. 

The ECB has launched "the sharpest and most aggressive cycle of rate hikes" in its history, said Carsten Brzeski, chief economist at ING Germany. These actions point to a paradigm shift in the regulator's activities. 

In a research note, Brzeski highlights signs of looming recession and growing economic uncertainty. In this context, "normalizing monetary policy is one thing," but stepping into restrictive territory is a whole new direction. Currently, rising interest rates may lead the ECB to pursue restrictive policy.