Euro Area: ECB hikes rates by 50 basis points in February; hints at further tightening ahead
At its 2 February meeting, the European Central Bank (ECB) hiked the main refinancing operations rate, the marginal lending facility and the deposit facility rate by 50 basis points to 3.00%, 3.25% and 2.50%, respectively. These increases, which matched market expectations, takes rates to their highest levels since 2008. Moreover, the ECB promised another half-point increase in March.
On top of this, the Bank confirmed that it will start to reduce its asset purchase program (APP) portfolio from March 2023, by EUR 15 billion per month on average, until June 2023. It added that the subsequent pace of reduction would be determined at a later date. Lastly, the ECB reiterated that it would reinvest the principal payments from maturing securities purchased under the pandemic emergency purchase program (PEPP) until at least the end of 2024—providing support to heavily indebted Southern European governments.
The decision to continue hiking was driven by still-elevated, albeit declining, inflation and above-target inflation forecasts. A stronger-than-expected economic performance in Q4 2022 and improved economic prospects for 2023 further supported the decision. Despite brighter-than-expected GDP data, the economy is nonetheless expected to remain weak in the first half of this year. That said, abundant stocks of gas provide a buffer against energy shortages that could hurt production. Meanwhile, the Bank now sees inflation risks as more balanced: Upside risks stem mainly from additional supply-chain disruption, the reopening of the Chinese economy and accelerating wage growth, while further falls in energy prices pose the main downside risk.
The Bank’s guidance pointed to additional tightening, stating that it expects to hike rates by 50 basis points in March and that it will subsequently “evaluate the […] path of its monetary policy”, factoring in all available data to guard against excessive inflation expectations and bring inflation to target. Therefore, the Bank reiterated that future moves would depend on the evolution of prices and the inflation outlook and would be determined meeting by meeting.
Commenting on the interaction between fiscal and monetary policies, Carsten Brzeski, global head of macro at ING, noted:
“The celebrated fiscal stimulus, which has eased recession fears, is indeed an additional concern for the ECB, as it could transform a supply-side inflation issue into demand-side inflation. These are two factors that could extend inflationary pressures in the Eurozone, albeit at a lower level than we see at the moment. As a consequence, we expect the ECB not only to continue hiking into late spring but also to keep interest rates high for longer than markets have currently penciled in.”
The next monetary policy meeting is scheduled for 16 March.