European Central Bank surprises markets with biggest interest rate rise in 20 years

‘Inflation continues to be undesirably high’, says Christine Lagarde

The European Central Bank increased interest rates for the first time in 11 years on Thursday in an attempt to cool inflation in the eurozone.

It raised rates by 50 basis points to 0pc – its biggest rise since 2000 – raising fresh fears that major economies could be plunged into recession at the cost of easing prices for households on food, fuel and everything in between.

The ECB’s surprise hike for the 19 countries using the euro currency is expected to be followed by another increase in September, possibly of another half a point. Bank president Christine Lagarde had indicated a quarter-point hike last month.

She said on Thursday that the bigger hike was unanimous as “inflation continues to be undesirably high and is expected to remain above our target for some time”. As the bank leaves an era of negative interest rates, Lagarde said the forecasts don’t point to a recession this year or next but she acknowledged the uncertainty ahead.

“Economic activity is slowing. Russia’s unjustified aggression towards Ukraine is an ongoing drag on growth,” the ECB chief said. Higher inflation, supply constraints and uncertainty “are significantly clouding the outlook for the second half of 2022 and beyond”.

The ECB is coming late to the party in its rate liftoff – a token of inflation that turned out to be higher and more stubborn than first expected and of the shakier state of an economy heavily exposed to the war in Ukraine and a dependence on Russian oil and natural gas. Recession predictions have increased for later this year and next year as soaring bills for electricity, fuel and gas deal a blow to businesses and people’s spending power.

“The economic outlook is worsening by the day,” said Carsten Brzeski, chief eurozone economist at ING bank. “At the same time, headline inflation is still increasing … In hindsight, the very gradual and cautious normalization process the ECB started at the end of last year has simply been too slow and too late.”

Recession concerns have helped push the euro to a 20-year low against the dollar, which adds to the ECB’s inflation fighting task by worsening already high energy prices. That is because oil is priced in dollars.

Alex Kuptsikevich, FxPro senior market analyst, said the euro’s slight gain on the dollar on Thursday “looks like just a technical rebound after a long decline”.

“Among the significant fundamental obstacles to the appreciation of the single currency is the European economy, which is deeply mired in an energy crisis, and the extremely high debt/GDP ratios of some of the larger economies, which reduce the scope for fiscal stimulus,” he said.

“Thus, there are many questions about the sustainability of euro growth in the near term despite a seemingly decisive ECB rate hike.”

Raising rates is seen as the standard cure for excessive inflation, now running at 8.6 per cent in the eurozone in June and largely driven by soaring energy prices. The bank’s benchmarks affect how much it costs banks to borrow – and so help determine what they charge to lend.

But by making credit harder to get, rate increases can slow economic growth, a major conundrum for the ECB as well as for the Federal Reserve. The Fed raised rates by an outsized three-quarters of a point in June and could do so again at its next meeting. The Bank of England started the march higher in December, and even Switzerland’s central bank surprised with its first increase in nearly 15 years last month.

Yet the European economy has the added worry of a potential cutoff of Russian natural gas that is used to generate electricity, heat homes and fuel energy-intensive industries such as steel, glassmaking and agriculture. Even without a total cutoff, Russia has steadily tightened gas flows, leading EU leaders to accuse the Kremlin of using gas to pressure countries over sanctions and support for Ukraine.

Those recession worries lead analysts to think that the path of ECB rate increases may have an upper limit after expected hikes in September and through the end of the year.

Brian Nick, chief investment strategist at Nuveen, said markets are looking to the ECB to bring down inflation across Europe, but “it will be extremely tricky to accomplish this without triggering a recession as the looming threat of higher gas prices hangs over consumers’ heads”.

Associated Press contributed to this report.