Projected ECB interest rates: How high can rates go as bank signals more hawkishness?

The European Central Bank (ECB) is reinforcing its aggressive policy stance amid persistently high inflation. 

The bank raised its interest rates by another 50 basis points (bps) in the February 2023 meeting, signalling that an equal hike should be expected in March. How high can interest rates go, and what are projected ECB interest rates in 5 years?

What is ECB?

ECB is the central bank in charge of monetary policy in the European Union (EU) member countries that use the euro (EUR) as their native currency. The currency union, which now includes 19 countries, is known as the eurozone.

Based in Frankfurt, Germany, the ECB has overseen the euro area’s monetary policy since the adoption of the euro in 1999.

The primary mandate of the ECB is to maintain price stability in the eurozone by ensuring that inflation does not exceed 2% in the medium term. As a central bank, it controls price growth by changing ECB interest rates, either raising them to discourage spending or lowering them to encourage consumption.

ECB interest rate decisions are made by the bank’s Governing Council, including the six members of the Executive Board and the 19 member countries’ national central-bank governors.

The council meets twice a month at the ECB's headquarters to assess the state of the economy and the currency every six weeks and to decide on monetary policy strategy.

Other ECB responsibilities include supervising eurozone banks, monitoring the financial system, printing euro banknotes, ensuring secure payment in euro by card or online, and investigating crypto assets.

ECB uses three rates in its monetary policy instruments toolkit:

• The ECB key rate, aka the refinancing rate or refi rate, applies when banks borrow money from ECB.

• The interest rate on the deposit facility, which banks may use to deposit funds overnight at a rate that is lower than the refi rate.

• 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.

ECB interest rate history

European Central Bank interest rates history shows that the central bank began its last policy easing cycle in 2008 amid the global financial crisis. The bank brought the rate from over 4.25% in 2008 to 1% in 2009. 

The ECB lowered its key rate to 0% in 2016, maintaining the zero-rate policy until July 2022, when it raised Eurozone interest rates to 0.5% – the first rate hike since 2011 – to curb the soaring inflation. 

Since then, the ECB has executed five rate hikes, most recently bringing the key rate to 3% in February 2023. The bank added that it intends to raise the rate by another 50 bps in March. The statement read:

The next ECB meeting is expected on 16 March. 

The recent hawkishness by the ECB appears to be helping the euro (EUR) against the US dollar (USD). As of 2 March, the  EUR/USD exchange rate has risen over 10% since late September’s lows, supported by the slowing of the US Federal Reserve’s (Fed) monetary tightening and some improvements in the eurozone's economy.

EUR/USD live exchange rate

Key factors affecting ECB interest rates

As evident from Lagarde’s statement, central banks typically make interest rate decisions based on economic metrics, such as inflation, gross domestic product (GDP) growth, and the unemployment rate. The outlook for these components will be key in understanding the projected ECB interest rate in 5 years. 

Inflation to stay above target through 2025 

Along with the latest policy announcement, the ECB’s survey of professional forecasters showed upward revisions to the inflation outlook for the next two years. 

The respondents’ inflation expectation stood at 5.9% for 2023 and at 2.7% for 2024, 0.1 and 0.3 percentage points higher than previous survey results. The upward revision reflects the change in core inflation expectations.

The survey respondents saw inflation at 2.1% in 2025, and the longer-term forecast for 2027 was revised down by 0.1 points to average at 2.1%.

Note that analyst predictions may be wrong

Source: ECB

Meanwhile, the eurozone’s inflation rate fell to 8.5% in February 2023. While the inflation rate has been trending downwards since the October 2022 peak, it's still well above the ECB’s 2% target and higher than expected by analysts. Daniela Hathorn, Capital.com's market analyst, commented on the reading: 

Will recession be avoided in Europe?

Economic growth, especially GDP, is another key reading for the ECB to consider when forming monetary policy. 

Meanwhile, the talk of a recession in Europe isn’t new. The eurozone's GDP growth rate has hovered below 1% quarter-on-quarter since late 2021, recently falling to as low as 0.1% in the fourth quarter of 2022, driven by contractions in Germany and Italy.

On a year-on-year basis, the eurozone’s economic growth slowed to 1.9% during the last quarter of 2022, the weakest growth since 2021.

According to Jane Foley, senior FX strategist at Rabobank, the drop in European gas prices in late 2022 caused a wave of relief over the economic outlook, supported by China's reopening given its trade links with Germany. However, the analyst noted: 

The ECB’s survey of professional forecasters signalled that a technical recession - which means two consecutive quarters of negative GDP growth - is likely to happen in the first three quarters of 2023. “Nearly all forecasters expected at least one quarter of negative growth, while 85% forecast a ‘technical recession’,” the survey results said. 

On a yearly basis, the forecasters saw the Eurozone's GDP growth at 0.2% in 2023, recovering to 1.4% and 1.7% in 2024 and 2025, before falling back to 1.4% in 2027. 

Note that analysts' predictions may be wrong

Source: ECB

Projected ECB interest rates in 5 years

With so many uncertainties at play, determining a realistic ECB interest forecast for the next 5 years is a challenging task. The bank itself provided projections for as far as 2025 in its survey of professional forecasters.

Their ECB interest rate prediction was for the rate to rise to 3% in the first quarter of 2023, a forecast that has already materialised, and to 3.5% in the second quarter, before easing slightly in 2024 and 2025 to below 3%.

ING’s policy rate forecasts, as of 2 March, saw the European Central Bank interest rate rising to 3.5% in the first quarter of 2023, then to 4% in the second quarter, where it would stay into early 2024. The Dutch bank’s analysts expected the rate at 3.5% in late 2024, and at 3% in late 2025. 

Economic data provider Trading Economics as of 2 March expected the rate to be at 3.5% by the end of this quarter, falling to 2.75% in 2024, and 1.5% in 2025, according to their econometric models.  

Note that analysts' predictions may be wrong

_{Source: ECB, ING, Trading Economics}

Final thoughts

Note that analysts’ ECB interest rate predictions can be wrong and should not be used as a substitute for your own research. Always conduct your own due diligence before trading, looking at the latest news, technical and fundamental analysis, and a wide range of commentary.

Remember, past performance does not guarantee future returns. And never trade money you cannot afford to lose.

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