European Central Bank Raises Rates, and Says ‘Significantly’ More to Come

The European Central Bank raised interest rates half a percentage point on Thursday, moderating its pace from recent meetings, but warned that rates would still need to climb “significantly” next year as the bank said inflation would be more stubborn than initially expected.

Policymakers have been trying to calibrate the right amount of braking needed to bring down record-high inflation, while the economy slows and the impact of previous rate increases starts to restrain activity. On Thursday, the E.C.B. used some of its most forceful language to indicate for the first time that monetary policy would need to be restrictive to tame inflation.

The annual rate of inflation in the eurozone slowed last month to 10 percent, the first deceleration in more than a year. Although it is an encouraging sign for central bankers, especially as it was accompanied by lower inflation rates in the United States and Britain, policymakers are not rushing to end their battle against high inflation. Staff at the E.C.B. said inflation would average higher than previously expected this year and next and would still be above the bank’s 2 percent target in 2025.

“The Governing Council judges that 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 to the 2 percent medium-term target,” the bank said in a statement on Thursday.

The euro jumped higher after the statement, reaching its highest level in more than six months. The currency reversed earlier losses and climbed 0.5 percent against the U.S. dollar to $1.07.

The decision follows a similar move by the Federal Reserve, which raised rates by half a point on Wednesday, and the Bank of England, which did the same on Thursday. All three central banks reduced the size of their rate increases from three-quarters of a percentage point at previous meetings.

Across the 19 countries that use the euro, prices are increasing at vastly different speeds. The annual rate of inflation last month slowed to 6.6 percent in Spain but in Estonia, Latvia and Lithuania, the rate remained above 21 percent.

And even if price increases are starting to slow, the outlook for inflation is uncertain and, in Europe, heavily influenced by volatile energy prices. Policymakers have been alert to signs that this period of high inflation is becoming embedded in the economy, especially through higher wage demands and higher prices for services. The E.C.B. predicted that core inflation, which excludes energy and food prices, would be above 4 percent next year, and would remain above 2 percent in 2025.

Last month, IG Metall, a large metalworkers union in Germany, agreed to wage increases of 5.2 percent next year and 3.3 percent in 2024, plus two lump sum payments. The pay negotiations were watched closely as a harbinger of wage demands across the eurozone’s largest economy.

In the end, the deal was far below Germany’s annual inflation rate, which was 11.3 percent in November. But Isabel Schnabel, one of the E.C.B.’s policymakers, has noted that the agreement was still a “much bigger” increase than in the past. The bank must be active in preventing a wage-price spiral, she said at a conference in London last month.

On Thursday, Christine Lagarde, the president of the E.C.B., said that wages in the region were growing at rates “well above” historical averages and would push up inflation over the next few years.

Some policymakers have also expressed concern about expensive and untargeted policies by European governments designed to insulate households from high energy prices, because this largess risks increasing economic demand, causing inflation to persist.

“Keeping interest rates at restrictive levels will over time reduce inflation by dampening demand and will also guard against the risk of a persistent upward shift in inflation expectations,” the bank said on Thursday.

From its July meeting through its one in October, the E.C.B. already raised interest rates by 2 percentage points, the fastest pace of tightening in the central bank’s two-decade history.

On Thursday, the central bank went further and increased its deposit rate, which is what banks receive for depositing money with the central bank overnight, from 1.5 percent to 2 percent, the highest since January 2009.

Ms. Lagarde had previously warned that a slowdown in economic growth, including a shallow recession, wouldn’t be enough to meaningfully slow inflation on its own and central bank action would still be needed.

The bank said that the eurozone economy might contract this quarter and the next one because of higher energy costs, economic uncertainty and the impact of tighter financial conditions. The bank’s staff lowered its forecasts for the eurozone economy next year, predicting it would grow 0.5 percent, down from a previous forecast of 0.9 percent.

As the bank moves further away from the extraordinary monetary policies of the past eight years that were designed to stoke economic demand and inflation, it said on Thursday it would also shrink the size of its substantial bond holdings.

Beginning in March, the asset purchase program, which holds bonds worth about 3.3 trillion euros ($3.5 trillion), will decline “at a measured and predictable pace” as the bank stops reinvesting all the proceeds from maturing assets, the bank said.

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