It marked the first time since 2011 that the ECB raised rates and brought Europe’s key interest rate back to zero. The coefficients in the region have been negative since 2014.
The move, which takes effect on July 27, comes as Europe struggles with record inflation fueled by soaring energy prices. Annual inflation in the European Union jumped to 9.6% in June. It reached 8.6% for the 19 countries that use the euro.
The central bank earlier indicated it would raise rates by a narrower margin, but decided it needed to be more aggressive based on an “updated assessment of inflation risk.”
“Inflation remains undesirably high and is expected to remain above our target for some time,” ECB President Christine Lagarde told a news conference.
The central bank refused to commit to a definitive trajectory for further interest rate hikes, trying to keep its options open.
“From now on, we will make our monetary policy decisions based on data,” Lagarde said. “We will work month by month and step by step. What happens in September will depend on what data we have for September.”
The ECB also unveiled a new bond-buying tool aimed at curbing borrowing costs in heavily indebted eurozone countries such as Italy and Greece. The central bank wants to maintain convergence in the region that uses the single currency.
The so-called Transmission Protection Instrument “could be activated to counter unwarranted, chaotic market dynamics that pose a serious threat to the transmission of monetary policy in the euro area,” the central bank said.
The European Central Bank is ready to deploy the instrument if necessary, provided countries meet certain indicators of fiscal and economic health, Lagarde stressed.
“I can assure you that we prefer not to use TPI,” she said. “But if we have to use it, we won’t hesitate.”
A web of risks
Investors reacted coolly to the announcement. The euro, which recently reached parity with the US dollar for the first time in two decades, rose after the announcement to around $1.02. European shares struggled to find direction, leaving the Stoxx 600 index unchanged.
The currency’s weakness makes the inflation problem even worse because it means European companies have to pay more for imports, including energy.
The ECB faces a tough climb as it steps up its efforts to stop rapid price rises. Although the summer tourist season, pandemic-era savings and a stable labor market continue to support the European economy, growth is slowing.
The central bank is not yet planning a recession. In June, the company said it expected output to grow 2.8 percent this year and 2.1 percent in 2023.
“The main scenario is that there is no recession, not this year or next year,” Lagarde said on Thursday, although she acknowledged that the horizon was “blurred”.
Recession risks could limit the ECB’s ability to keep raising interest rates, which helps fight inflation but also slows the economy.
The ECB is already lagging far behind its peers. After cutting interest rates to zero at the start of the pandemic, the Federal Reserve has been raising interest rates since March, raising its benchmark interest rate by huge steps in the past few months to fight rampant inflation. Only the Bank of Japan, which on Thursday kept its ultra-loose policy, has not budged.
It also has to deal with a high degree of uncertainty regarding energy supplies, which makes it difficult to predict future inflation.
Russia’s Gazprom resumed gas supplies on the key Nord Stream 1 pipeline on Thursday, allaying fears that it would not come back online after a scheduled maintenance period. But it is not operating at full capacity and concerns persist that Russia may still cut off the gas at some point in retaliation for Western sanctions.
In addition, Europe’s third-largest economy is in the midst of a political crisis that is shaking the country’s financial markets. Italian Prime Minister Mario Draghi, an investor favorite, tendered his resignation to the president on Thursday after losing the support of several key parties in the ruling coalition. This could lead to early elections.
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