The European Central Bank decided on Thursday to increase the three key interest rates by 75 basis points, making a dramatic change from the prevailing transition accommodative rates' levels to ensure a timely return to the ECB's inflation target of 2%.
This means the ECB intends to raise interest rates further to dampen demand and guard against persistent inflation. But the ECB governing Council will decide the future flexible policy rate on data and a meeting-by-meeting approach.
In effect inflation remains too high and is likely to stay above target for an extended period, Eurostat's estimates inflation in August reached 9,1%, with soaring energy and food prices, as well as demand pressures and supply bottlenecks. In July it was 8,9%. ECB staff have significantly revised up their inflation projections and inflation is now expected to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.
The Governing Council decided to raise the three key ECB interest rates by 75 basis points. Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 1.25%, 1.50% and 0.75% respectively, with effect from 14 September 2022.
Following the raising of the deposit facility rate to above zero, the two-tier system for the remuneration of excess reserves is no longer necessary. The Governing Council therefore decided today to suspend the two-tier system by setting the multiplier to zero.
After a rebound in the first half of 2022, recent data point to a substantial slowdown in euro area economic growth, with the economy expected to stagnate later in the year and in the first quarter of 2023. Very high energy prices are reducing the purchasing power of people’s incomes and, although supply bottlenecks are easing, they are still constraining economic activity. In addition, the adverse geopolitical situation, especially Russia’s unjustified aggression towards Ukraine, is weighing on the confidence of businesses and consumers. This outlook is reflected in the latest staff projections for economic growth, which have been revised down markedly for the remainder of the current year and throughout 2023. Staff now expect the economy to grow by 3.1% in 2022, 0.9% in 2023 and 1.9% in 2024.
ECB has been rather late in joining the US Federal Reserve and other leading central banks in the rush to raise rates to combat inflation. The increase is aimed at raising borrowing costs for consumers, businesses and governments. This theoretically slows spending and investment while taking the heat off of consumer prices by reducing demand for goods.
The ECB, like many other central banks for developed western economies, has consistently held interest rates at or near zero almost without interruption since the so-called financial crash of 2008. The target was to promote economic growth and moderate inflation of around 2%.