ECB raises rates to 2% and warns of more increases to come

Christine Lagarde warned markets not to expect an early end to rate rises next year, on a day when the European Central Bank and the Bank of England lifted borrowing costs to their highest levels in 14 years.

The two central banks raised interest rates by 0.5 percentage points, following an equivalent increase this week by the US Federal Reserve. In comments that reflected the challenge many central banks are facing in wrestling down inflation, BoE governor Andrew Bailey said the UK’s tight labour market and rises in wages and prices justified “a further forceful monetary policy response”.

Lagarde, ECB president, said the central bank had “more ground to cover, we have longer to go”, than the Fed. “The ECB is not pivoting,” she added, promising at least two more 0.5 percentage point rate increases in February and March.

Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said the ECB’s message was “very, very hawkish”.

The ECB raised its deposit rate from 1.5 per cent to 2 per cent and announced plans to start shrinking the €5tn-worth of bonds it has acquired over the past eight years from March. It warned inflation would remain above its 2 per cent target in three years, which meant it had to keep raising rates significantly to squeeze economic growth.

“Interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation,” the bank said. The BoE raised interest rates to 3.5 per cent — like the ECB, the highest level since 2008 — and warned that further tightening of monetary policy was likely.

Six of the nine members of the BoE’s Monetary Policy Committee backed the increase, with one favouring a larger 0.75 percentage point rise. Sterling fell and the price of UK government debt rallied after the announcement, which markets saw as marginally less hawkish than the ECB’s.

Central banks on both sides of the Atlantic have warned further action is needed to curb price rises, despite signs inflation has peaked. Economists said this week’s slowdown in rate rises reflected fears that inflation could prove “sticky” and take too long to return to target levels of 2 per cent.

The US and European economies also appear increasingly likely to slide into recession in the coming months.

Lagarde said it was “pretty much obvious that on the basis of the data we have at the moment” rate-setters expected “to raise interest rates at a 50 basis-point pace for a period of time”.

Vítor Constâncio, a former ECB vice-president, criticised the move, writing on Twitter that it indicated “an excessively hawkish policy that will aggravate the coming recession unnecessarily”.

The ECB has now increased interest rates at each of its past four meetings by a total of 2.5 percentage points, its most aggressive set of rises since the euro was created in 1999.

Eurozone inflation fell from a record high of 10.6 per cent in October to 10 per cent in November. However, the bank on Thursday lifted its inflation forecast for this year to 8.4 per cent, 6.3 per cent next year and 3.4 per cent in 2024.

Lagarde said the higher estimates were based on the view that food and energy prices would rise more than expected in the coming months.