President of the European Central Bank Christine Lagarde attends a hearing of the Committee on Economic and Monetary Affairs in the European Parliament on November 28, 2022 in Brussels, Belgium.
Thierry Monasse | Getty Images News | Getty Images
The European Central Bank opted for a smaller rate hike at its Thursday meeting, taking its key rate from 1.5% to 2%.
It also said that from the beginning of March 2023 it would begin to reduce its balance sheet by 15 billion euros ($16 billion) per month on average until the end of the second quarter of 2023.
It said it would announce more details about the reduction of its asset purchase program (APP) holdings in February, and that it would regularly reassess the pace of decline to ensure it was consistent with its monetary policy strategy.
The widely-expected 50 basis point rate rise is the central bank’s fourth increase this year.
It hiked by 75 basis points in October and September and by 50 basis points in July, bringing rates out of negative territory for the first time since 2014.
The euro rose from a 0.5% loss against the dollar to a 0.4% gain following the announcement, but European equities in the Stoxx 600 index plunged 2.4%.
“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% medium-term target,” the ECB said in a statement.
The central bank said it was working on inflation forecasts that had been “significantly revised up,” and sees inflation remaining above its 2% target until 2025.
It now expects average inflation of 8.4% in 2022, 6.3% in 2023, 3.4% in 2024 and 2.3% in 2025.
However, it sees a recession in the region being “relatively short-lived and shallow.”
It comes after the latest inflation data for the euro zone showed a slight slow in price rises in November, although the rate remains at 10% annually.
At a press conference following the announcement, ECB President Christine Lagarde told CNBC’s Annette Weisbach: “One of the key messages, in addition to the hike, is the indication that not only will we raise interest rates further, which we had said before, but that today we judged that interest rates will still have to rise significantly, at a steady place.”
“It is pretty much obvious that on the basis of the data that we have at the moment, significant rise at a steady pace means we should have to raise interest rates at a 50 basis point pace for a period of time,” she said.
Regarding the announcement on quantitative tightening, she said the ECB wanted to follow the principles of being predictable and measured.
The central bank’s decision to make on average 15 billion euro reductions in its APP over four months represents roughly half the redemptions over that period of time, and was based on advice from its market team and all central banks and other officials involved in its decision making, Lagarde explained.
“It seemed an appropriate number in order to normalize our balance sheet, bearing in mind that the key tool is the interest rate,” she said.
The U.S. Federal Reserve on Wednesday increased its main rate by 0.5 percentage points, as did the Bank of England and Swiss National Bank on Thursday morning.
“In contrast to the Bank of England, this is a hawkish hike, given the language on [quantitative tightening] and a definitive start date,” said analysts at BMO Capital Markets.
However, they noted the ECB was lagging other central banks in reducing its balance sheet and that reinvestments under its pandemic emergency purchase program would continue.
“The language in the statement has an operational feel to it, and the Bank is leaving the path of QT open-ended,” they wrote in a note.