Europe's central bank is set to pile on another rate increase. Is it the last in a record series?
The European Central Bank is set to raise interest rates again Thursday
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Your support makes all the difference.The European Central Bank is set to raise interest rates at least one more time to fight inflation, even as worries about recession fuel speculation that Thursday's hike could be the last in its yearlong campaign to ease price hikes by making borrowing more expensive for companies and consumers.
ECB President Christine Lagarde has all but promised an increase as the bank's governing council meets in Frankfurt, where interest rates are decided for the 20 European Union countries that use the euro.
Higher rates, she said last month, are needed to squelch inflation that is proving more persistent than anticipated, underlining that “we cannot waver, and we cannot declare victory yet.”
Like the U.S. Federal Reserve, the ECB is approaching the end of its rate increases, leading analysts to focus on whether it will raise rates again at its September meeting or call a halt. The Fed raised its key rate on Wednesday for the 11th time in 17 months, and Chair Jerome Powell was noncommittal about any expectations for future rate hikes. Inflation is lower in the U.S. — at 3% — than it is in Europe.
Higher rates are the typical medicine against inflation, which at 5.5% in the eurozone is down from a double-digit peak in October but still far from the bank's target of 2%. Higher rates work by making it more expensive for people to get loans to buy homes and cars or for companies to get new equipment or build facilities, meaning they typically spend less and prices come down.
The ECB's rapid series of rate hikes — from minus 0.5% to 3.5% in one year, the fastest tightening cycle since the euro was introduced in 1999 — is already slowing demand for goods.
The outlook for construction companies in Germany hit its lowest level since 2010 and a yearslong rally in home prices across the eurozone has come to an end. Demand for business loans or lines of credit in the April-to-June period was the lowest since 2003, according to a quarterly ECB survey.
Fears about recession are focusing on Germany, Europe's industrial powerhouse and largest economy. It is the only developed economy that the International Monetary Fund expects to shrink this year.
Germany's manufacturing sector is contracting sharply, according to a purchasing managers' index compiled by S&P Global, which recorded an abysmal 38.8 points in June. Anything below 50 indicates shrinking activity.
Germany has recorded two straight quarters of falling economic output, meeting one definition of recession. It might have seen a third, with figures for the April-to-June period coming out Friday.
The German economy is going through a “slowcession” — "stuck in the twilight zone between stagnation and recession,” says Carsten Brzeski, chief eurozone economist at ING Bank.
The whole eurozone economy also shrank slightly in the first three months of the year, likewise the second straight quarterly decline. Preliminary figures for the second quarter are due Monday.
The economists on the euro area business cycle dating committee, which declares recessions, use a broader set of data than just two quarters of shrinking output figures in its decisions. The committee said June 30 that talk of a eurozone recession was “premature” given record low unemployment of 6.5%.
The slowdown is in many ways a response to the shock from brutally high energy prices caused by Russia’s war against Ukraine. Energy inflation has slowed, but higher prices have seeped through the rest of the economy — making groceries, clothes and household items more expensive and eroding consumer spending power.
“We expect Thursday's ECB decision to mark the end of its hiking cycle,” said Geoffrey Yu, foreign exchange and macro strategist for Europe, the Middle East and Africa at BNY Mellon.
Yu pointed to comments from ECB council member Klaas Knot, who called a further hike at the bank's Sept. 14 meeting “by no means a certainty.” The remarks carry added weight because Knot has tended to favor higher rates.
Analysts at Berenberg bank see a 60% chance of another increase at the ECB's September meeting but added that the likelihood is rising that it will hold off.
A quarter-point increase Thursday would bring the ECB's benchmark deposit rate to 3.75%.