The European Central Bank (ECB) has hiked interest rates for the for the first time in 11 years as inflation appears less transitory than it had originally anticipated.
It was slower than other central banks to react to the cost-of-living crisis but was forced into action as inflation rose to 8.6% in June.
The 50 basis point rise was higher than some had anticipated and Chris Beauchamp, chief market analyst at IG Group, said it was a clear sign that the bank is “serious about the challenges it faces”.
Inflation in the UK and US is higher than Europe, but both their central banks began hiking rates earlier in December last year, meaning the ECB may have some catching up to do.
Managing the monetary policy of all 19 countries within the European Union (EU) adds an extra layer of difficulty when setting interest rates, with senior associate at Validus Risk Management Jesús Cabra Guisasola stating that “the ECB has possibly the most difficult balancing act of all the major central banks”.
Garry White, chief investment commentator at Charles Stanley noted that raising rates too quickly could damage the performance of long-term bonds in places such as Italy and Greece “dramatically,” which could result in stagflation and recessions in those countries if not handled carefully.
He said: “The prospect for the euro remains gloomy in the months ahead as the ECB is facing one of the most difficult moments since the creation of the institution as the central bank is hiking to curb inflation while trying to keep under control the spread in yields between southern countries and Germany.”
Likewise, the resignation of Italian prime minister, Mario Draghi, this morning, will pile another element of uncertainty onto the ECB’s troubles.
“Inflation is not their only preoccupation, unlike the other western central banks,” White added.
Higher energy prices are likely to drive up inflation over the coming months, with Europe’s dependency on Russian gas being highlighted over the past 10 days of maintenance on the Nord Stream 1 pipeline, which delivers 40% of the continent’s gas.
Much of Europe held its breath wondering whether Russian president Vladimir Putin would turn it back on at all – it was resumed in the early hours of this morning, but at 40% capacity.
With inflation set to rise further over the next few months, it’s likely we will see another hike after the next ECB meeting in September.
Beauchamp said: “The bank’s record on raising rates is hardly encouraging, but with inflation running so hot this is a clear statement of intent that has markets scrambling to price in a more hawkish policy in the months to come.”
Gero Jung, chief economist at Mirabaud Group expects equally steep hikes of 50bps at both of the next ECB meetings as the bank attempts to get high inflation under control.