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The European Central Bank stated on Thursday that it would increase its main interest rate by a half percentage point in a daring effort to rein in inflation.
That brings Europe’s primary rate back to zero and is the first rate increase by the ECB since 2011. Since 2014, rates in the area have decreased.
The decision, which becomes effective on July 27, comes as Europe struggles with record-high inflation fueled by rising energy prices. The European Union’s annual inflation rate in June increased to 9.6%. The 19 nations that use the euro got as high as 8.6%.
Initially planning to raise rates by a lesser margin, the central bank changed its mind after conducting an “updated assessment of inflation risk,” which convinced it that it needed to be more proactive. In an effort to maintain flexibility, the central bank chose not to commit to a certain trajectory for future rate increases.
The ECB also announced a brand-new bond-purchasing instrument to contain borrowing costs in heavily indebted eurozone nations like Italy and Greece. The region’s single currency-using central bank seeks to maintain cohesion within it.
The so-called Transmission Protection Instrument “may be triggered to prevent unjustified, chaotic market dynamics that constitute a substantial threat to the transmission of monetary policy across the euro area,” according to the central bank.
If necessary, the European Central Bank will use the tool, Lagarde reiterated, provided that the nation in question meets certain criteria for budgetary and economic soundness.
The European Central Bank takes an unpopular decison
The announcement was received very lukewarmly by investors. Following the revelation, the euro, which just reached parity with the US dollar for the first time in twenty years, rose to roughly $1.02. However, the Stoxx 600 index was flat as European companies were unable to gain momentum.
Due to the increased cost of imports, notably energy, for European businesses as a result of the currency’s depreciation, inflation is becoming a bigger issue.
As it intensifies its attempts to halt the sharp rise in prices, the ECB confronts a difficult battle. Growth is weakening, despite the European economy still being supported by the summer travel season, savings from the pandemic, and a strong employment market.
The central bank has not yet projected a recession. On the contrary, it predicted that output would increase by 2.1 percent in 2023 and 2.8 percent this year in a statement made in June.
Already, the ECB lags behind its competitors by a wide margin. Since March, the Federal Reserve has begun raising interest rates aggressively in an effort to rein in inflation after reducing rates to zero at the start of the pandemic. The only institution that has not changed is the Bank of Japan, which kept its ultra-easy policies on Thursday.
Furthermore, it must deal with significant energy supply uncertainty, which makes predicting future inflation challenging.
After a period of planned maintenance, Russia’s Gazprom resumed gas exports via the vital Nord Stream 1 pipeline on Thursday, easing concerns that it wouldn’t be operational again. However, it isn’t functioning at full capacity, and concerns persist that Russia might potentially cut off the gas at some point in response to Western sanctions.
A deepening political crisis is shaking the financial markets of the third-largest economy in Europe. After losing the support of several significant parties in his governing coalition, market favorite and Italian Prime Minister Mario Draghi presented his resignation to the president on Thursday. Elections might take place sooner as a result.