ECB Rates: Europe Joins Inflation Fight With First Increase in 11 Years

FRANKFURT — As consumer prices across Europe soar at the fastest rate in generations, officials in Frankfurt on Thursday took a powerful step to control rapid inflation amid mounting concerns over an economic slowdown.

In the first move of its kind in over a decade, the European Central Bank raised its three interest rates half a percentage point, an increase that was twice as large as telegraphed and that follows similar measures taken by the Federal Reserve and dozens of other central banks around the world this year.

The global outlook has worsened in recent months, as inflation rises in seemingly every corner of the economy and pandemic-induced disruptions continue to wreak havoc on supply chains. For the eurozone, the bloc of 19 countries that use the euro, the dimming outlook has been particularly acute.

With war on its doorstep, and as the cost of powering businesses, heating homes and feeding families becomes increasingly unaffordable, the European Central Bank is grappling with profound uncertainty. Christine Lagarde, the bank’s president, gave few signals on Thursday about what comes next.

Consumer prices in the eurozone rose on average 8.6 percent last month from a year earlier. The last time inflation was this bad in the region, the euro didn’t exist. That has placed the European Central Bank in uncharted territory.

“Inflation continues to be undesirably high” and is expected to remain so for some time, Ms. Lagarde said at a news conference on Thursday. The latest economic data “indicate a slowdown in growth, clouding the outlook for the second half of 2022 and beyond,” she said.

Amid fears over Europe’s energy supply from Russia, and with the economic outlook worsening, the central bank said it chose to “front-load” its rate increases. In one swoop, the bank ended an eight-year era of negative interest rates — a policy dating to 2014, when the concern was too-low inflation and banks needed to be encouraged to lend more generously.

The European Central Bank has acted more slowly to rein in inflation than some of its international peers, such as those in Britain and Canada, because it has been hit harder by sources of inflation that are out of its control, such as the global supply chain disruptions and rising energy prices caused by Russia’s invasion of Ukraine.

Policymakers in Europe have also been more cautious than those at the Federal Reserve in the United States, where tight labor markets and strong consumer demand mean officials need to cool the economy.

“The E.C.B. is still deploying a distinctly more accommodative monetary policy than other major central banks,” Wolfgang Bauer, a fund manager at M&G Investments, wrote in a note.

The bank’s deposit interest rate is at zero, but the key policy rate in Britain is 1.25 percent and the Fed’s is set to a range of 1.5 to 1.75 percent. “If inflation continues to reign supreme, there is still a lot of catching up to do,” Mr. Bauer wrote.

Ms. Lagarde said an “updated assessment of inflation risks” had led to the decision to raise rates by double the amount forecast at its last meeting. Another reason, she said, was the bank’s approval of a new policy tool aimed at preventing “unwarranted” disparities in eurozone countries’ borrowing costs that would impede the effectiveness of monetary policy.

The increase in inflation in June was more than the bank had predicted, and last week, the euro fell to parity with the dollar for the first time in 20 years. That added to the bloc’s inflationary pressures because the lower currency value increased the cost of imports.

Even after the unexpected half-point increase, the bank “is moving much too slowly toward an interest rate level that is appropriate in view of high inflation,” Jörg Krämer, the chief economist at Commerzbank, wrote in a note to clients.

Policymakers raised the deposit rate, which is what banks receive for depositing money with the central bank overnight, from minus 0.5 percent to zero. Further rate increases are likely to come at subsequent meetings, the bank said, but future decisions will be made at each meeting depending on data. The bank has a target of 2 percent inflation over the medium term and didn’t give any signals on how big future increases might be.

At her news conference, Ms. Lagarde took pains to lay out all of the economic clouds gathering: Growth was slowing down, the war in Ukraine was a drag on growth, high inflation was increasing the cost of living, and businesses were facing higher costs and continued supply chain disruptions.

But the central bank’s mandate is price stability, so acting to ease inflation must be seen to be its priority, even as price increases vary wildly across the bloc. Inflation ranges from around 6 percent in Malta to over 20 percent in Estonia.

Raising interest rates was the crucial next step in ending the European Central Bank’s era of ultraloose monetary policy support. The bank has already ended its multitrillion-euro programs to buy bonds. The rate increases will go into effect on Wednesday.

On Thursday, the bank also introduced a policy tool to limit the divergence in borrowing costs across the eurozone’s 19 members, which it said was part of the reason it was able to raise interest rates more than expected. Tightening monetary policy had revived investors’ concerns about the fiscal stability of the bloc’s most indebted members.

In recent months, rapidly rising borrowing costs for Italy, which has the second-highest debt burden in the eurozone, intensified the focus on whether bond market moves were in line with economic fundamentals or speculative trading that threatened the effectiveness of monetary policy. That assessment was complicated even further on Thursday when Mario Draghi, Ms. Lagarde’s predecessor at the central bank, resigned as prime minister of Italy. After just 17 months, the coalition government he led in an effort to bring about economic reforms fell apart.

The bank’s new policy tool, the Transmission Protection Instrument, is intended to stop disorderly moves in government bond markets. In short, the new tool will allow the bank to buy the bonds of countries it believes are experiencing an unwarranted deterioration in financing conditions. But as there was when an earlier policy instrument was announced in the depths of the 2012 European debt crisis, there is a hope that the announcement alone will calm bond markets and that the tool will not have to be used.

The last time the bank raised rates, in July 2011, policymakers reversed the move just four months later as a crisis in the region’s bond markets intensified.

These days, policymakers are walking a fine line between easing price pressures and drawing the European economy into a recession. And analysts are questioning how high the bank can raise rates before the economic outlook deteriorates too much and the bank has to stop. Ms. Lagarde said on Thursday that the larger-than-expected rate increase didn’t change how high the bank expected to raises rates overall, though she didn’t say what rate the central bank was aiming to reach. Analysts at Commerzbank expect rates to peak at 1.5 percent next spring.

Concern is growing that the bloc will enter a recession, especially if Russian natural gas supplies are cut off or gas rationing hampers industrial production, halting rate increases sooner than expected. On Wednesday, the European Commission urged member countries to immediately start rationing the use of the fuel to avoid energy shortages that would stall economic growth and leave households cold in the winter.

“An economic downturn is ahead, and the question is more about the extent of that downturn,” said Nick Kounis, the head of financial markets and sustainability research at ABN Amro. “Right now, of course, the focus is very much on inflation, but if they do get into a situation where the economy is stagnating or even contracting and unemployment starts to rise significantly, that could start to change the balance of the risks.”

Reporting was contributed by Jeanna Smialek, Joe Rennison, Isabella Simonetti and Patricia Cohen.

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