The European Central Bank (ECB) increased interest rates by a quarter of a percentage point on Thursday, signaling another hike for the following month, despite indications of a mild recession in the Eurozone consisting of 20 countries.
The ECB has been consistently raising rates at each meeting since July as a measure to combat inflation. This latest adjustment brings the benchmark rate in the Eurozone to 3.5%, the highest since May 2001.
Diverging from the US Federal Reserve's decision to pause its rate-hiking campaign after ten consecutive increases, ECB President Christine Lagarde expressed confidence in another rate hike occurring in July.
Lagarde stated that the ECB was not considering pausing and emphasized the need to further raise interest rates to achieve a sufficiently restrictive monetary policy. The ECB also highlighted in a statement that inflation, although declining, is projected to remain persistently high.
In May, consumer prices in the Eurozone rose by 6.1% compared to the previous year, marking the lowest level since the escalation of the Russia-Ukraine conflict that led to a surge in global energy prices.
While inflation has moderated, it still surpasses the ECB's 2% target, raising concerns about ongoing price pressures. The central bank revised its forecast for core inflation, citing "upward surprises" and a strong labor market, with expectations that it will reach 5.1% this year, up from the average forecast of 4.6% in March.
Lagarde attributed the increase in core inflation to wage growth, with average wages rising by 5.2% in the first quarter compared to the previous year. Despite stagnant output, companies have been raising prices due to rising labor costs per worker.
Although the Eurozone experienced historically low unemployment of 6.5% in April, Lagarde stated that ECB policymakers extensively discussed the labor market and would closely monitor further developments.
Nevertheless, the region's economy is beginning to feel the impact of higher interest rates and increasing prices, leading to a slight contraction around the start of the year.
The ECB adjusted its economic growth forecast, anticipating a growth rate of 0.9% for the year, slightly lower than its March projection.
The effects of previous rate increases are gradually permeating the economy, with borrowing costs rising steeply and loan growth slowing down, potentially strengthening the case for the central bank to pause its rate hikes in the near future.
However, the ECB foresees inflation remaining elevated for an extended period, leaving the door open for additional rate hikes beyond July.
Analysts, such as Claus Vistesen, Chief Euro Area Economist at Pantheon Macroeconomics, predict that the ECB will implement two more 25-basis-point rate hikes, in July and September, which would bring the deposit rate to 4%—what they believe will be the final rate adjustment.
