In a bid to counter stubborn inflation, the European Central Bank (ECB) increased its deposit rate to an all-time high of 4% from 3.75% on Thursday. This marks the tenth consecutive rate hike since July last year. However, the ECB also signaled that it is likely done with the tightening policy, suggesting a pause and potential rate cuts in the second half of next year.
The decision came as a surprise to markets, which had anticipated unchanged rates only days before Thursday's meeting. Expectations shifted after a source indicated that the ECB would raise its 2024 inflation projection in new forecasts.
The ECB's Governing Council stated, "Based on its current assessment, the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target."
However, policymakers face a challenging balancing act between stubbornly high price growth figures and rising recession fears. Inflation remains above 5%, with markets not expecting it to fall back to the ECB's 2% target even in the longer term due to an exceptionally tight labor market and high energy costs.
Growth prospects are quickly fading, partly due to higher interest rates. Even services, long considered the bloc's bright spot, have started to weaken, increasing the risk of recession. The new economic projections from the ECB reflect these shifts and could stoke fears of stagflation—a period of economic stagnation accompanied by high inflation.
The bank revised its forecasts for eurozone inflation in 2023 to 5.6%, and in 2024 to 3.2%. It also lowered its forecast for 2025 inflation to 2.1%. Growth projections were cut to 0.7% for this year and 1.0% for 2024.
The ECB reaffirmed its commitment to returning inflation to its 2% medium-term target in a timely manner. It stated, "The Governing Council's future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary."
The focus now shifts to ECB President Christine Lagarde's news conference scheduled for 1245 GMT.
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