European Central Bank hikes rates to historic high but hints it could pause

The European Central Bank raised interest rates by a quarter of a percentage point Thursday but hinted it could pause at its next meeting, as data points to a deepening economic downturn in the 20 countries that use the euro.

The ECB hiked the benchmark rate in the euro area to 3.75 per cent, which matches the highest rate since the launch of the euro currency in 1999. Borrowing costs were previously jacked up this high only in October 2000, CNN reports.

“Inflation continues to decline but is still expected to remain too high for too long,” the central bank said in a statement.

The ninth consecutive hike by the ECB followed another rate increase by the US Federal Reserve, which raised benchmark borrowing costs Wednesday — also by a quarter of a percentage point — to their highest level in 22 years.

US and European policymakers remain concerned about consumer prices, although there is growing evidence that interest rate hikes are starting to tame inflation while also dampening economic activity.

Traders are convinced the Fed is done hiking, giving an 80 per cent probability to no change at its next meeting, according to the CME FedWatch Tool.

The ECB, meanwhile, is entertaining its first pause since it started hiking a year ago.

“We have an open mind as to what the decisions will be in September and in subsequent meetings,” ECB President Christine Lagarde told journalists, adding “we might hike [or] we might hold.”

Rate cuts are not on the table, however. “That is a definite no,” Lagarde said.

Several analysts pointed to a subtle change in the ECB’s language compared with June. The bank said this month that rates will be “set at,” rather than “brought to,” sufficiently restrictive levels.

“This hints that today’s hike could be the last, but it is by no means certain,” Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, said in a note.

European economy weakening

Recent evidence suggests the euro area may be stuck in recession, bolstering the case for a pause.

Demand for business loans fell to a record low in the second quarter, according to a survey published by the ECB on July 25. The report also found that banks had tightened credit standards further across all loan categories.

Separately, survey data released on July 24 showed that business activity in the eurozone contracted at the fastest pace in eight months in July.

An initial reading of the Purchasing Managers’ Index, which tracks activity in the manufacturing and service sectors, dropped to 48.9 from 49.9 in June. A reading below 50 indicates a contraction.

“Manufacturing continues to be the Achilles heel of the eurozone,” said Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, which produces the research in partnership with S&P Global.

“The eurozone economy will likely move further into contraction territory in the months ahead as the services sector keeps losing steam.”

Gross domestic product figures for the second quarter due out on July 24 will confirm whether the euro area is still in a recession.

Consumer prices in the region rose 5.5 per cent in June compared with a year ago — a sharp slowdown from a record 10.6 per cent in October 2022 but still well above the ECB’s 2 per cent target.

Core inflation, which strips out volatile food and energy prices, inched down only slightly, suggesting that “underlying inflation has … plateaued,” Commerzbank senior economist Marco Wagner said in a note on July 26.

With core inflation higher in the euro area but interest rates “substantially lower” than in the United States, Capital Economics thinks the ECB will deliver one more rate hike but that the Fed’s tightening cycle is now over.