ECB hikes rates again

The European Central Bank raised interest rates again sharply on Thursday, as policymakers sought to quell record-high inflation in the region.

The central bank, which sets monetary policy for the 19 countries that use the euro, raised interest rates by three-quarters of a percentage point, unchanged from the previous hike last month. After a slow start to rate hikes — the first in more than a decade in July — the bank said it had quickly tightened its policy stance as inflation turned out to be worse and more persistent than the bank had expected.

Consumer prices in the euro zone rose an average of 9.9% year-on-year in September, the fastest pace on record, driven by energy and food prices.

“Inflation remains too high and will remain above target for a long time,” central bank governor Christine Lagarde said on Thursday. She said the central bank’s policy stance was aimed at weakening the push higher the strength of demand and guard against the risk of persistently higher inflation expectations.

Ms Lagarde added at a news conference in Frankfurt that policymakers wanted to raise interest rates further to bring inflation back to the bank’s 2 percent target.

The challenge for central bankers has grown over the past few months as lawmakers do more to protect households and businesses from rising prices. The central bank governor warned that fiscal policy cannot run counter to monetary policy. The UK has become an international model for this risk. Last week, Liz Truss resigned as prime minister after tax cuts sparked turmoil in financial markets.

European governments are divided over how to deal with rising energy prices, with rich nations taking advantage of their better fiscal positions to boost spending. Germany recently announced a 200 billion euro ($201 billion) aid package for its households, businesses and industries.

The ability of central bankers to control inflation has been severely tested over the past year. There was an expectation that high inflation would pass quickly, especially when it was largely driven by highly volatile energy prices beyond the control of policymakers. But economies face a series of economic shocks that have prompted central banks to act.

While inflation is well above the central bank’s 2 percent target, analysts have begun to question how high euro zone policymakers can raise interest rates as a recession looms.

The bank’s deposit rate, the rate banks earn on overnight deposits at the central bank, was raised to 1.5 percent on Thursday, with the new rate set to take effect on Nov. 2. The bank also raised rates on two other key lending rates by 3-quarter points. It remains a relatively accommodative policy stance compared with some international peers. In the US, the Fed’s policy rate target is between 3% and 3.25%. The Bank of England’s main policy rate is set at 2.25%.

ECB officials have said they need at least a neutral rate, where policy neither stimulates nor constrains economic growth, but estimates vary and the central bank has not disclosed its own.

While inflation is expected to remain above the central bank’s target for the next two years, the future path of inflation is increasingly uncertain. Gas prices in Europe, which have recently declined, have had a major impact on inflation as weather remains relatively warm and governments have successfully filled storage facilities. But prices are still double what they were a year ago, and analysts say prices could still rise sharply again. Winter futures contracts are higher and inventories are expected to be lower.

Policymakers are also closely watching how much businesses raise prices and how much workers demand higher wages to combat high inflation. For now, these second-round effects appear to be contained, but once prices are expected to continue to rise, it will be difficult to control inflation.

One source of comfort for policymakers may be the euro. On Wednesday, it climbed back above $1 for the first time in more than a month. Officials have been wary of how a weak euro could exacerbate inflationary pressures by raising the cost of imports.

On Thursday, the bank also announced it would change the terms of loans it offers to banks during the pandemic. These are designed to give banks cheap access to capital and encourage lending to businesses and households.

But as inflation rises and central banks raise interest rates, the loans present an arbitrage opportunity for European banks to make money on their central bank holdings. Interest rates on these loans will rise from next month, with banks encouraging early repayments.

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