European Central Bank makes largest-ever interest rate hike

By DAVID McHUGH
AP Business Writer

FRANKFURT, Germany (AP) — The European Central Bank made its largest-ever interest rate increase Thursday, following the U.S. Federal Reserve and other central banks in a global stampede of rapid rate hikes meant to snuff out the inflation that is squeezing consumers and pushing Europe toward recession.

The bank’s governing council raised its key benchmarks by an unprecedented three-quarters of a percentage point for the 19 countries that use the euro currency. The ECB usually moves rates by a quarter-point and had not raised its key bank lending rate by three-quarters of a point since the euro’s launch in 1999.

Bank President Christine Lagarde said the ECB would keep hiking rates “over the next several meetings” because “inflation remains far too high and is likely to stay above our target for an extended period.”

Lagarde stopped short of predicting a recession, though many economists foresee one at the end of the year and beginning of 2023 as high energy and food prices sap people’s spending power. The bank’s assumption is economic output would not fall outright but “stagnate” later this year and early next, she said.

The bank’s jumbo increase is aimed at raising the cost of borrowing for consumers, governments and businesses, which in theory slows spending and investment and cools off soaring consumer prices by reducing the demand for goods.

Analysts say it’s also aimed at bolstering the bank’s credibility after it underestimated how long and how severe this outbreak of inflation would be. After reaching a record 9.1% in August, inflation may rise into double digits in coming months, economists say.

The war in Ukraine has fueled inflation in Europe, with Russia sharply reducing supplies of cheap natural gas used to heat homes, generate electricity and run factories. That has driven up gas prices by 10 times or more.

European officials decry the cutbacks as blackmail aimed at pressuring and dividing the European Union over its support for Ukraine. Russia has blamed technical problems and threatened this week to cut off energy supplies completely if the West institutes planned price caps on Moscow’s natural gas and oil.

The ECB has lagged other central banks in raising rates. Central banks worldwide have scrambled after being wrong-footed by inflation fed by the war in Ukraine and the lingering effects of the COVID-19 pandemic, which have sent energy prices higher and restricted supplies of parts and raw materials.

The sudden campaign to raise interest rates follows years in which borrowing costs and inflation stayed low because of broad trends such as globalization, aging populations and digitalization.

Lagarde rejected comparisons, saying that “we’re not trying to mimic any other central bank” and pointing out that the ECB started tightening monetary policy in December, when it decided to phase out its pandemic stimulus through bond purchases.

Some economists say the ECB’s interest rate hikes, including a half-point hike at its last meeting in July, could deepen a European recession predicted for the end of this year and the beginning of 2023, caused by higher inflation that has made everything from groceries to utility bills more expensive.

Lagarde said a 2022-23 recession would occur only under a “really dark” worst-case scenario where all Russian natural gas is cut off, alternative supplies are not available and governments have to resort to energy rationing.

She praised efforts by the EU’s executive Commission to contain energy prices, such as through electricity market regulation, and noted that while rate hikes send “a strong signal” of the bank’s commitment to fight inflation, “I cannot reduce the price of energy.”

But the bank has reasoned that rate hikes will prevent higher prices from being baked into expectations for wage and price deals and that decisive action now will forestall the need for even bigger hikes if inflation gets ingrained.

Europe’s central bank “wants to fight inflation — and wants to be seen as fighting inflation,” said Holger Schmieding, chief economist at Berenberg bank.

However, energy prices and government support programs to shield consumers from some of the pain will “have a much bigger impact on inflation and the depth of the looming recession than monetary policy,” he said.

Rate hikes often support a currency’s exchange rate — but the euro has been under pressure because of more general fears about recession and economic growth. It has recently fallen under $1, the lowest level in 20 years. The euro slid about a half-cent after the ECB decision, to around 99.5 U.S. cents.

The ECB’s benchmark is now 1.25% for lending to banks. The Fed’s main benchmark is 2.25% to 2.5% after several large rate hikes, including two of three-quarters of a point. The Bank of England’s key benchmark is 1.75%, and the Bank of Canada raised rates Wednesday by three-quarters of a point, to 3.25%.