On Thursday, the European Central Bank (ECB) increased the interest rates by 25 basis points to reach 3.25 percent, in line with market expectations. Additionally, the ECB announced that it would discontinue the practice of reinvesting funds from maturing debt in its Asset Purchase Program, which is worth 3.2 trillion euros, starting from July.
The central bank for the 20 countries that share the euro has now lifted rates by a combined 375 basis points since last July, its fastest pace of tightening, but further action is still likely given mounting wage and price pressures.
The rate hike, a slowdown after three consecutive 50 basis point increases, comes only days after eurozone banking data showed the biggest drop in loan demand in over a decade. That suggests previous rate rises are working their way through the economy and that ECB policies are now restricting growth.
The bank, however, provided no guidance on future moves.
“The Governing Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction,” the ECB said in a statement.
“Rate decisions will continue to be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission,” it added.
Policymakers had been split in the run up to the meeting between a 25 basis point and a 50 basis point rise but markets and economists had overwhelmingly bet on the smaller increase after soft data in recent weeks and similar moderation by other big central banks.
Supporting the case for a smaller move, the eurozone economy barely grew last quarter and banks were tightening access to credit, raising the risk that such a trend could morph into a full-blown credit crunch and drag further on growth.
Underlying inflation has also stopped rising – at least for the time being.
Adding to the case for caution, most big central banks around the world are now moving in 25-basis-point increments after big hikes earlier, and the US Federal Reserve even signaled on Wednesday that it could pause.
“Overall, the incoming information broadly supports the assessment of the medium-term inflation outlook that the Governing Council formed at its previous meeting,” said the ECB, which has missed its 2 percent inflation target for the past decade.
But like peers including the Bank of England, the ECB is still seen raising borrowing costs several times before a hitting peak rate of 3.75 percent some time this summer, as inflation could take years to come back to its 2 percent target.
Although overall inflation has fallen sharply from last autumn’s double-digit readings, underlying price pressures are still building, suggesting that price growth could level off above the ECB’s target unless the bank hikes further.
These risks are exacerbated by a tight labor market, especially since wage growth has been quicker than predicted and the jobless rate has fallen to an all-time-low despite the near-recessionary environment.