ECB Signals First Interest Rate Hike in 11 Years in July...Possibility of 0.5%P 'Big Step' Increase in September

"0.25%P Increase in July, Asset Purchases Also Ending"
September Inflation Expected to Exceed 9%... Concerns Over Stagflation

[Image source=EPA Yonhap News]

[Asia Economy Reporter Hyunwoo Lee] The European Central Bank (ECB), which had maintained a cautious stance despite interest rate hikes by the United States and various central banks, announced that it will begin raising interest rates by 0.25 percentage points starting in July to curb the rapid inflation rate. It also hinted at the possibility of a so-called 'big step' with a larger increase in September compared to July. Amid the energy and food crises triggered by the Ukraine situation, major central banks worldwide are all entering a tightening phase in earnest, raising concerns about stagflation due to economic recession caused by the shock of interest rate hikes.

On the 9th (local time), the ECB held a monetary policy meeting and announced that it would raise the benchmark interest rate, currently at 0%, by 0.25 percentage points starting in July and raise it again in September. This is the first time in 11 years that the ECB has announced an interest rate hike. The ECB had continuously lowered rates since the Southern European financial crisis in 2011 and maintained a 0% interest rate for over six years after lowering the benchmark rate to 0% in March 2016.

Along with this, the ECB announced that it would end its quantitative easing policy starting in July. Under the current Asset Purchase Programme (APP), the ECB said it would stop bond purchases from July 1. Previously, bond purchases were conducted at a scale of 20 billion euros (about 27 trillion won) per month, increased to 40 billion euros (about 54 trillion won) in April, 30 billion euros (about 40 trillion won) in May, and then reduced back to 20 billion euros in June. The special liquidity provision under the Targeted Longer-Term Refinancing Operations (TLTRO III) is scheduled to end on the 23rd of this month.

In a statement released after the meeting, the ECB explained the reasons for the rate hikes in July and September, saying, "Last month's inflation rate rose significantly due to soaring energy and food prices caused by the Ukraine situation and other factors. The broadening and intensifying inflationary pressures pose a serious challenge, and we will ensure that the inflation rate returns to the medium-term target of 2%."

In particular, the possibility of a larger rate hike in September than in July was raised, suggesting a big step. The ECB said, "We plan to raise the benchmark interest rate again in September," adding, "If the medium-term inflation outlook is maintained or worsens, a larger increase will also be appropriate." This has strengthened the speculation of a 0.5 percentage point rate hike that had been raised since last month.

Following the ECB's big step announcement, European stock markets plunged across the board. Germany's Frankfurt stock market DAX index closed at 14,198.80, down 1.71% from the previous trading day's closing price; the UK's London stock market FTSE 100 index fell 1.54% to 7,476.21; and France's Paris stock market CAC 40 index dropped 1.40% to 6,358.46.

As the market shock was greater than expected, the ECB reiterated its gradual approach to rate hikes. ECB President Christine Lagarde emphasized at a press conference after the meeting, "It is a journey, not just a single step," adding, "In times of great uncertainty, gradualism is probably appropriate, but it would be even better if the path is clear, well confirmed, and everyone understands where we are heading."

However, pessimistic views are spreading that it will be difficult to pursue gradual rate hikes amid rapidly rising inflation. In May, the Eurozone's inflation rate hit a record high of 8.1%. In particular, energy costs such as oil and natural gas rose by 39.2%, leading the rise in other items. Due to Russia's weaponization of food, prices of food, alcoholic beverages, and tobacco also surged by 7.5%.

The inflation forecast announced by the ECB on this day was also revised upward to 6.8% for this year, 3.5% for 2023, and 2.1% for 2024. All figures exceed the ECB's medium- to long-term inflation target of 2%. Especially with concerns that energy prices will rise further from September, when demand for heating natural gas increases in the fall, some predict that the Eurozone inflation rate will exceed 9%. Even if interest rates are raised sharply, inflation is expected to continue as long as Russia's invasion war in Ukraine, the main cause of inflation, does not end, increasing concerns about an economic recession.

This content was produced with the assistance of AI translation services.