The European Central Bank (ECB) has decided to raise its benchmark deposit rate by a quarter-percentage point to 3.75 per cent, matching a high last seen in 2001. This move marks the ninth consecutive rate increase and comes on the heels of the US Federal Reserve’s similar decision to raise rates.

ECB President Christine Lagarde’s announcement has sent ripples through the financial markets. Although inflation has been a key concern, she indicated that eurozone borrowing costs may have reached their peak, suggesting that a pause could be on the horizon. However, she did not rule out the possibility of a further hike, citing the importance of forthcoming economic data in shaping future decisions.

Investors, on the other hand, seem to be betting against further rate increases, as inflation is falling faster than expected on both sides of the Atlantic. While the Fed has recently signaled more tightening, traders are increasingly convinced that these rate hikes might be the last from both central banks.

Following the ECB’s announcement, the euro fell 0.8 per cent to $1.099, indicating that the market believes the central bank might be ready to conclude its tightening campaign. Meanwhile, the US dollar was bolstered by strong second-quarter GDP figures, showing a robust annualized growth rate of 2.4 per cent.

Despite the decline in inflation, the ECB remains cautious and committed to monitoring price pressures closely. The bank’s previous policy statement aimed to bring interest rates to levels “sufficiently restrictive” to achieve its 2 percent inflation target. However, the language has been modified, stating that rates will now be set at sufficiently restrictive levels for as long as necessary. Inflation currently stands at 5.5 per cent, nearly three times the target level.

The move to increase rates is not without its concerns. Some analysts worry that the rate hikes could exacerbate an economic downturn, especially considering recent evidence suggesting that the eurozone might be stuck in a recession. Demand for business loans has hit a record low, and survey data indicates a contraction in business activity, especially in the manufacturing sector.

The ECB’s decision to raise rates and potentially pause reflects the delicate balancing act policymakers face in addressing inflation concerns while safeguarding economic growth. As the world watches the global economic landscape evolve, the financial markets eagerly await further clues from both the ECB and the Fed regarding their future monetary policy paths.

By: Montel Kamau Serrari Financial Analyst 27th July, 2023

photo source Google