The European Central Bank held off on raising interest rates on Thursday, but confirmed plans for a hike next month in a bid to fight inflation.
The bank announced that it would raise the cost of borrowing by 25 basis points in July — its first rate hike in more than a decade — and said a bigger hike could follow in September “if the medium-term inflation outlook persists or deteriorates.”
“Inflation is undesirably high and is expected to remain above our target for some time,” ECB President Christine Lagarde said at a press conference.
The ECB raised its forecast for annual inflation in the eurozone “significantly” to 6.8% this year, and said it would remain just above its target of 2% in 2024. It also cut its growth forecasts. GDP for the 19 countries that use the euro is now projected to rise by 2.8% in 2022 and by just 2.1% next year.
Eurozone inflation hit an all-time high of 8.1% last month, according to Eurostat.
The war in Ukraine has fueled global inflation and exerted pressure on the European Union to find alternatives to Russian oil and gas, on which it is heavily reliant. Europe has agreed to wind down its exports — introducing phased embargoes on oil and coal — and is now scrambling to source alternative supplies of energy at a time of soaring fossil fuel prices.
Lagarde said that energy prices were almost 40% higher than in May 2021, and would remain high in the near term.
“If the war were to escalate economic sentiment could worsen, supply side constraints could increase, and energy and food costs could remain persistently higher than expected,” she said.
The ECB has been slower in moving to tackle inflation than its counterparts in the United Kingdom and United States, which have both raised rates in the past few months. But its task is more tricky as Europe is more directly exposed to the economic fallout from the war in Ukraine.
The central bank is trying to strike a delicate balance between raising rates to hold down rising prices, but not by so much that it tips the region into a recession.
Bill Papadakis, a macro strategist at Bank Lombard Odier, told CNN Business that the ECB’s decision to raise rates and wrap up its bond buying program from July 1 were the “right moves.”
But the prospect of a larger hike in September could be a mistake, he said.
“More costly energy eats into consumers’ real incomes, undermining growth, which is likely to suffer if the ECB goes ahead with aggressively tighter monetary policy,” he said.
There is some reason for optimism, though. High levels of employment and the reopening of sectors that were shut during the pandemic are among factors supporting consumption, Lagarde said.
“The conditions are in place for the economy to continue to grow and to recover further over the medium term,” she said.