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Business News/ Markets / Stock Markets/  At 3.75%, ECB hikes rates to historic 23-year high as it battles inflation; signals further policy tightening
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At 3.75%, ECB hikes rates to historic 23-year high as it battles inflation; signals further policy tightening

The ECB increased its key interest rate - the one banks pay to park cash securely at the central bank - for the ninth consecutive time, by 25 basis points to 3.75 per cent, its highest level since 2001.

A European Union (EU) flag flies outside of the headquarters of the European Central Bank (ECB) in Frankfurt, Germany, Photographer: Hannelore Foerster/BloombergPremium
A European Union (EU) flag flies outside of the headquarters of the European Central Bank (ECB) in Frankfurt, Germany, Photographer: Hannelore Foerster/Bloomberg

The European Central Bank (ECB) on July 27 lifted interest rates by another quarter-point - to their highest level in 23 years and kept its options open on whether more increases will be needed to bring down inflation against a worsening economic backdrop.

The ECB increased its key interest rate - the one banks pay to park cash securely at the central bank - for the ninth consecutive time, by 25 basis points to 3.75 per cent, its highest level since 2001. This comes less than a day after the US Federal Reserve hiked borrowing rates to a 22-year high level between 5-25 per cent- 5.50 per cent, in order to tackle sticky inflation.

“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 to achieve a timely return of inflation to the two per cent medium-term target," the ECB said in a statement. “The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction."

Borrowing costs have risen at their fastest pace ever in the bank's year-long hiking cycle to fight inflation. Inflation was "still expected to remain too high for too long", added the ECB.

Overall, rates have risen by 4.25 percentage points since the ECB made its first move in July last year after Russia's invasion of Ukraine sent prices for energy and food soaring. The current 3.75 per cent level was last seen in May 2001 and equal to its previous record high.

ECB President Christine Lagarde emphasized that the economic situation is deteriorating, and that there will be two inflation releases before its next meeting, which will also feature new forecasts for growth and inflation.

The ECB will keep an "open mind" on future interest rate decisions, Lagarde said in a post-policy press conference, potentially opening the door to a pause in its hiking campaign. "We are deliberately data dependent, we have an open mind as to what the decisions will be in September and in subsequent meetings," she added.

Consumer prices in the eurozone rose at 5.5-percent pace in June -- down from last year's double-digit peak but still well above the ECB's two-per cent target. Collectively, the 20 countries in the currency bloc fell into recession around the turn of the year, shrinking for two straight quarters.

Overall, inflation would "drop further over the remainder of the year but will stay above target for an extended period", the ECB said on Thursday. "While some measures show signs of easing, underlying inflation remains high overall," the central bank said.

Core inflation -- a closely watched measure that excludes volatile energy, food, alcohol and tobacco prices -- in fact rose to 5.4 per cent in the eurozone in June, from 5.3 per cent in May. Officials at the Frankfurt-based central bank are now more worried about the impact of rising wages as workers demand higher salaries to cover increased costs.

Among other key decisions, the ECB announced that it will stop paying banks for the money they are required to keep at the institution as a minimum reserve, a move that could cut into banks’ interest income.

The ECB “set the remuneration of minimum reserves at 0 per cent," it said in a statement on Thursday along with its monetary policy decision. The central bank had previously lowered the amount paid on minimum reserves.

Europe’s banks most recently were required to stash about 165 billion euros at the ECB as minimum reserves, according to data through June 20 on the central bank’s website. The central bank paid 3.25 per cent on that amount, translating into annual income of about 5.4 billion euros ($6 billion).

The move is likely to further reduce windfall profits from interest rate increases to lenders, who have benefited over the past year as they were able to earn more for loans while keeping rates paid on deposits near zero. 

Market movement after ECB rate hike

European stocks rallied to the highest since February last year after the region’s central bank raised interest rates as expected while keeping options open for the next meeting, reassuring investors that policymakers are nearing the end of their cycle of monetary tightening.

The Stoxx Europe 600 Index climbed 1.4 per cent by the close in London. Tech stocks jumped 4.4 per cent, the most since early February, while most sectors were in the green amid a busy day of earnings.

On Wall Street, the three main indexes firmed, with the Dow and benchmark S&P 500 on track for their 14th straight daily gains. The Dow Jones Industrial Average rose 0.19 per cent to 35,586.45, the S&P 500 gained 0.58 per cent to 4,593.19 and the Nasdaq Composite rose 1.13% to 14,287.49.

The dollar rose against a basket of its major peers after the rate hikes. The dollar index rose 0.574 per cent, while the euro reversed gains to drop 0.78 per cent to $1.0997 after the ECB rate hike decision.

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Published: 27 Jul 2023, 06:25 PM IST
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