European Central Bank raises interest rates to 3.75%

Bank president says economic outlook in the eurozone has deteriorated

The ECB had been expected to deliver another increase. AFP

The European Central Bank raised interest rates on Thursday to 3.75 per cent – following the lead of the US Federal Reserve – in its battle against inflation.

It was the bank's ninth straight increase and took the closely-watched deposit rate to 3.75 per cent – a level last hit in May 2001 and equal to its previous record high.

ECB President Christine Lagarde said that the eurozone's economic outlook has deteriorated and added that another rise could take place next month.

“Inflation continues to decline but is still expected to remain too high for too long,” the ECB said. “While some measures show signs of easing, underlying inflation remains high overall.

“The past rate increases continue to be transmitted forcefully: financing conditions have tightened again and are increasingly dampening demand, which is an important factor in bringing inflation back to target.”

The Fed raised US interest rates by 25 basis points on Wednesday, its 11th increase since March 2022 as part of US attempts to lower inflationary pressure.

The ECB's statement refers to rates having to be brought to a level that cuts inflation quickly enough, a nuanced change that could be seen as a signal that further increases are not a given.

Weaker domestic demand and high inflation are dampening supply and weighing on manufacturing. Momentum is also slowing in service sectors, Ms Lagarde said, adding that as the energy crisis fades governments must avoid inflationary pressure.

“Fiscal policies must be designed to make our economies more productive,” she said.

“The near-term economic outlook for the euro area has deteriorated, owing largely to weaker domestic demand.

“High inflation and tighter financing conditions are dampening spending. This is weighing especially on manufacturing output, which is also being held down by weak external demand.

“The economy is expected to remain weak in the short run. Over time, falling inflation, rising incomes and improving supply conditions should support the recovery.”

She added: “We have an open mind as to what the decisions will be in September and in subsequent meetings. So we might hike and we might hold.”

Ms Lagarde said that if the bank pauses interest rate increases, “it would not necessarily be for an extended period of time”.

The euro pushed higher against a softer dollar ahead of the ECB’s announcement.

“Having put down a marker with its recently increased in-house inflation forecasts the ECB now finds itself, like some other central banks, in the difficult spot of trying to balance still uncomfortably high [core] inflation with the obvious – yet incomplete – impact of past rate hikes on households and businesses,” said Des Lawrence, senior investment strategist at State Street Global Advisers.

“We would not regard a 25 basis point rate hike at the September meeting as unreasonable given the still elevated inflation numbers and projections. Beyond that we think there is a good case in favour of holding policy rates steady at those levels for some time.”

Last month, the ECB raised its benchmark interest rate by 25 bps to 3.5 per cent.

Fed chairman Jerome Powell was equivocal about whether there was one more policy rate rise left this year and said the banking regulator's staff were no longer forecasting a recession.

However, futures markets continue to expect a less than 50 per cent chance of another move.

The central banks of the UAE, Saudi Arabia, Bahrain, Kuwait, Oman and Qatar raised their benchmark borrowing rates after the US Federal Reserve pushed its key interest rate to a 22-year high to tame inflation and restore price stability.

Next week the Bank of England updates British rates.