29th Sep 2023

ECB hikes rates for ninth time, despite recession fears

  • ECB president Christine Lagarde has overseen the steepest increase of borrowing costs in the EU's recent history (Photo: European Central Bank)
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The European Central Bank raised interest rates for the ninth consecutive time on Thursday (27 July), even as the risk of recession is growing.

The bank has now increased borrowing costs by 4.25 percent since last summer, to the highest it has been since the euro was introduced.

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Worried that high-profit growth over the last year may lead to a "tit for tat" increase in wage demands which would fuel further inflation necessitated another rate hike, ECB president Christine Lagarde said on Thursday.

"Demand in Europe is starting to dampen, which is necessary to bring down inflation to two percent," she added.

The ECB's problem is that inflation is coming down too slowly and could take until 2025 to fall back to two percent.

If inflation is driven by too much spending, the solution is to bring spending down, which is what higher interest rates are intended to do.

But demand in Europe today is lower than it was in 2019.

US Federal Reserve chief Jerome Powell this week also decided to raise interest rates, but spending in the US has increased by over seven percent since 2019.

The European Central Bank's own quarterly bank lending survey published on Tuesday showed corporate borrowing has not been this low since the financial crisis of 2008, painting a bleak picture of the eurozone economy in the coming months.

This apparent weakness has led economists to criticise the ECB for following a similar tightening path despite the different economic situation.

While the US has tightened the money supply "from a position of strength" and has a shot of disinflation "without a 'deep' recession," Sander Tordoir, who is a senior economist at the Centre for European Reform, tweeted on Thursday, "Such hope if there ever was one, seems faint for the eurozone."

€150bn bank subsidy

The bank's governing council also decided to stop paying out interest rates over minimum reserves. This means commercial banks will incur a loss of €6.1bn of missed interest payments.

However, the ECB will continue to pay out interest on excess reserves.

This means that under the current 3.75 percent deposit rate, the ECB is set to pay €150bn in net interest to commercial banks on the accumulated reserves they deposited with central banks (a little over €4 trillion collectively).

London School of Economics professor of economics Paul de Grauwe has previously told EUobserver that this constitutes a bank subsidy.

ECB rate hikes see corporate loans drop to record low

According to the ECB lending survey, demand for corporate loans fell 42 percent in the second quarter of 2023, and 38 percent in the first quarter. "The decrease was again substantially stronger than expected by banks," the ECB reported.

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