ECB raises rates, ditches Fed

The European Central Bank (ECB) announced on Thursday its decision to raise its main rate by 25 basis points to 3.5%, diverging from the U.S. Federal Reserve’s decision to pause its own rate hikes. The ECB has been gradually increasing rates since July 2022 in an effort to curb record-high inflation in the region. However, the latest inflation data showed a faster-than-expected cooling, with headline inflation at 6.1% in May and core inflation at 5.3%, well above the ECB’s 2% target.

While the market anticipated the ECB’s decision, there remains uncertainty about its future actions beyond the summer. The ECB stated that its future decisions will aim to bring the interest rates to sufficiently restrictive levels to achieve a timely return of inflation to the 2% target. Despite the recent slowdown in inflation, the ECB actually raised its expectations for both headline and core inflation for this year and the next. It now projects headline inflation at 5.4% in 2023, 3% in 2024, and 2.2% in 2025.

In terms of growth outlook, the ECB revised its numbers downward, expecting a growth rate of 0.9% this year and 1.5% in 2024, compared to previous estimates of 1% and 1.6% respectively. Following the announcement, the euro strengthened against the U.S. dollar, and European bond yields increased.

ECB President Christine Lagarde emphasized that the central bank is not considering pausing its rate hikes, stating that they are not at their destination yet. She indicated that another potential rate hike could occur in July. Lagarde also expressed dissatisfaction with the inflation outlook and suggested that the terminal rate would be determined when they reach it. However, the poor economic performance of the eurozone, including a technical recession in the first quarter of this year, may limit the ECB’s ability to further raise rates to combat inflation. Nevertheless, ECB officials have previously emphasized the importance of tackling inflation over avoiding an economic slowdown.