Introduction

The European Central Bank (ECB) has raised borrowing costs to their highest level in 22 years on Thursday. It left the door open to more hikes, extending its fight against high inflation even as the euro zone economy flags.

ECB Raises Interest Rate for Eighth Consecutive Time

The ECB increased its key interest rate by 25 basis points to 3.5%, its highest level since 2001. This is the eighth consecutive time that the ECB has raised the interest rate.

Inflation Expected to Remain Above Target

The central bank for the 20 countries that share the euro also said it expected inflation to stay above its 2% target through 2025 and hinted once again at more rate hikes in the coming months.

Growth in Euro Zone Stagnating

Growth in the euro zone is at best stagnating and inflation has been moderating for months, courtesy of lower energy prices and the steepest increase in interest rates in the ECB’s 25-year history.

US Federal Reserve Breaks Its Own String of Rate Hikes

Late on Wednesday, the U.S. Federal Reserve broke its own string of 10 successive rate hikes – a powerful signal to investors around the world that the current tightening cycle across developed economies is nearing an end, even if a little more U.S. tightening is still possible.

Inflation in the Euro Zone Still Unacceptably High

But inflation in the euro zone is still unacceptably high for the ECB at 6.1% and underlying price growth, which typically excludes food and energy, is only starting to slow.

ECB to Continue Tightening Path

That was set to keep the ECB on the tightening path, particularly after it failed to predict the current bout of high inflation and began raising rates later than many global peers last year.

Economists Expect Another Rate Hike in July

Economists polled by Reuters before Thursday’s decision expected another 25-basis-point deposit rate hike in July, as flagged by a host of policymakers.

Mixed Picture

The ECB raised its inflation forecasts for this year, the next and 2025, when it was still expected to remain above the central bank’s target, at 2.2%

While this would normally augur a pause in policy tightening, the ECB has been taking its own projections with a pinch of salt after years in which they missed the mark.

Actual Economic Data Painting a Mixed Picture

Instead, rate-setters have focused on actual economic data that have been painting a mixed picture.

Unemployment at Record Lows

Two quarters of contraction in industrial powerhouse Germany dragged the euro zone into a shallow recession last winter and the economy is likely to eke out only modest growth this year.

But unemployment is at record lows and wage growth is picking up, even if it still lags inflation.

Opposing Factors Providing Ammunition to Both Sides of ECB’s Governing Council

Headline price growth has been falling fast after hitting double-digits late last year. But underlying prices, most notably for services, have yet to show the decisive drop ECB policymakers have said they would need to see before taking their foot off the monetary brake.

Higher borrowing costs are curbing demand for credit from households and companies as well as banks’ willingness to lend, but consumption is holding up well in nominal terms.

“The Governing Council’s past rate increases are being transmitted forcefully to financing conditions and are gradually having an impact across the economy,” the ECB said in the statement.

These opposing factors were likely to have provided ammunition to both sides of the ECB’s Governing Council – the hawkish majority that has been pushing for more rate hikes and a minority of doves who have been advocating a pause.