ECB rate hikes: Will the central bank hike again?
Rattled by the war between Russia and Ukraine which has taken a toll on energy and food prices, the European Central Bank (ECB) hiked its key interest rates for the first time in 11 years. The ECB has joined other central banks in implementing a more aggressive stance to tame soaring inflation with bigger-than-expected rate increases.
What will be the outlook for the next ECB rate hikes and will the European central bank maintain its hawkish monetary policy? Here we take a look at the history of ECB rate hikes, the latest rate decision and forecast from analysts.
What is ECB?
What does ECB stand for? ECB, or the European Central Bank (ECB), is the central bank in charge of monetary policy in the European Union (EU) member countries that use the euro (EUR). The eurozone is the name given to this currency union, which now consists of 19 countries.
ECB’s primary mandate is to maintain price stability in the eurozone making sure that inflation won’t exceed 2% in the medium term. Like any other central bank around the world, it controls inflation by changing its ECB interest rates, either by increasing the rates to curb spending or lowering rates to encourage consumption.
Other ECB roles include supervising banks in the euro area, monitoring the financial system, printing euro banknotes, ensuring secure payment for consumers in euro by card or online and investigating crypto assets.
Based in Frankfurt, Germany, the ECB has been in charge of the euro area’s monetary policy since the adoption of the euro on 1 January 1999.
The idea of a unified currency and economy started when the European Council confirmed the realisation of the Economic and Monetary Union (EMU) in June 1988. The council mandated a committee chaired by then President of the European Commission Jacques Delors to study and propose stages for the union.
Stage one started in 1990 with free use of the European currency unit, the forerunner of the euro, and increased cooperation between central banks.
Stage two began in 1994 and included the ban on the granting of central bank credit, increased coordination of monetary policies and preparing for the final stage.
During the final stage three that started in 1999, introduction of the euro and adoption of single monetary policy by the European System of Central Banks were officially begun, marking the start of the euro zone area.
The ECB's Governing Council, which consists of the six members of the Executive Board and the governors of the national central banks of the 19 countries that make up the euro area, determines monetary policy decisions.
At the ECB's headquarters, the council has its twice-monthly meetings. Every six weeks, it evaluates the state of the economy and the currency and makes monetary policy decisions.
In non-monetary policy meetings, the council discusses other tasks and responsibilities of the ECB and the euro system.
History of ECB interest rates
ECB uses three rates in its monetary policy instruments toolkit:
The interest rate for the main refinancing operations is the ECB key rate, the ‘refi rate’. It is the interest rate that applies when banks borrow money on a weekly basis from the ECB in exchange for security and at a predetermined interest rate.
The interest rate on the deposit facility, which banks may use to deposit funds overnight at a rate that is lower than the rate for main refinancing operations.
The marginal lending facility's interest rate, which provides overnight credit to banks at a pre-set interest rate above the main refinancing operations rate.
Data on ECB interest rates history shows that the central bank started its low-interest rate policy in October 2008 by cutting its main refinancing operations interest rate by 50bp to 3.75% amid the escalating financial crisis in 2008.
It continued to cut the key interest rate until it stood at 1% by May 2009. It maintained that level until April 2011.
The ECB lifted its main interest rate by 25bp in April 2011 to 1.25% as inflation in the euro ran up to 2.6% in March 2011, above its target of 2%. It had another 25bp increase in July 2011 to 1.50% before it cut the rate by 25bp back to 1% in December 2011.
ECB maintained its rate at 1% until July 2012 when it lowered its main rate by 10bp to 0.75%. Between July 2012 to September 2014, the ECB cut its refi rate four times to near zero.
It maintained the key rate at 0.05% from September 2014 to March 2016 when it lowered the rate by 5bp to 0.00%. ECB kept its zero interest rate until 27 July 2022 when it made its first ECB rate hike since 2011.
ECB hikes rates for the first time in 11 years
In July, the ECB increased interest rates for the first time since 2011 to control the euro zone's unchecked inflation. The Governing Council decided to raise the three key ECB interest rates by 50 basis points which exceeded analysts expectations of 25bp.
In its aggressive tightening policy, the ECB followed other central banks including the US Federal Reserve (Fed) which hiked its key rate by 75bp in June.
The hikes brought the ECB interest rates on the main refinancing operations; the marginal lending facility and the deposit facility to 0.50%, 0.75% and 0.00%, respectively, the central bank said in a statement on 21 July.
Eurostat figures showed that the annual inflation in the Eurozone area surged to a record high of 8.6% in June, rising from 5.1% in January 2022 and 1.9% in June 2021. Rising prices of energy, food, alcohol, and tobacco were the main contributors driving up the inflation.
The ECB rate hike came as Europe is facing a slowing growth outlook due to the war in Ukraine and heightened fear of recession due to problems with gas supply from Russia.
The European Commission forecast that the EU economy will grow by 2.7% in 2022, slowing to 1.5% in 2023. Growth in the euro area was expected at 2.6% in 2022, moderating to 1.4% in 2023.
Will the ECB hike again?
When is the next ECB interest rate decision? The central bank is scheduled to convene for a policy meeting on 8 September.
What do analysts expect from the ECB interest rate decision in September?
ING’s global head of macro, Carsten Brzeski, expected a total 100bp rate hike over the summer or until October, the analyst said in a podcast on 22 July.
Capital Economics expected another 50bp ECB interest rate hikes in September and October, followed by 25bp in December to bring rates to 1.25% by the end of the year.
The company predicted the deposit rate will be lifted to around 2% next year.
Rupert Thompson, investment strategist at asset-management company Kingswood, expected a 0.50% hike in his ECB interest rates forecast for September.
In its ECB rate hike expectations Rabobank forecast another 50bp rate hike in September with an upside risk of 75bp and 50bp increase in October, and 25bp in December.
The Dutch lender based its projection on two assumptions: that the TPI will effectively reduce fragmentation risks in the Eurozone and that the economic outlook will not worsen significantly in the coming months.
Bank of America (BofA) in a note on 18 July, before the ECB’s rate meeting, forecast a 50bp rate hike in September and October, and a final hike of 25bp in December.
The bottom line
Most analysts mentioned in this article forecast ECB rate hikes of 50bp each in September and October, followed by a 25bp in December amid expected rising inflation.
Remember that analysts’ views can be wrong. Forecasts should not be used as a substitute for your own research. Always conduct your own due diligence before trading or investing. And never invest or trade money you cannot afford to lose.
What happens when interest rates rise?
When a country’s central bank raises its benchmark interest rate, it tends to increase borrowing costs for individuals and businesses, discouraging spending. Other rates, such as mortgage and business loans rates, can also increase. Higher rates means that investors are rewarded more for saving money.
How do rate hikes affect inflation?
Changing interest rates is a monetary policy tool to control inflation. When the rate is raised, borrowing costs increase, which tends to discourage individuals and businesses to borrow money for spending, such as buying a car or a house, building a new plant or buying new equipment for business expansion. As individuals and businesses spend less, demand for goods and services declines, which can lead to lower prices and prevent prices from rising faster.
How do rate hikes affect the stock market?
A rate hike could affect a company’s earnings and stock performance as it becomes more expensive to raise funds for investment. Companies must also pay higher interest rates for the bonds they issue.