ECB Slows Rate Hikes, Signals More Tightening Amid Eurozone Recession

(RTTNews) - The European Central Bank slowed the pace of its interest rate hikes, as expected, but said there is a need for significant tightening in future as it markedly lifted the euro area inflation forecast and projected a recession for the single currency bloc during the first half of next year. The central bank also revealed its initial plans to trim its portfolio and said it will stop reinvestment of bond sale proceeds.

The Governing Council, led by ECB President Christine Lagarde, raised the key interest rates by 50 basis points, the ECB said in a statement on Thursday, in sync with its peers the US Federal Reserve and the Bank of England.

The main refinancing rate, or the refi, was thus raised to 2.50 percent, the deposit facility rate to 2.00 percent and the marginal lending rate to 2.75 percent.

The central bank was widely expected to slow the pace of monetary policy tightening this time after inflation came off slightly in several countries on the back of a modest easing in energy prices, leading to a rebound in confidence indicators.

However, the ECB said policymakers expect to raise rates further based on the substantial upward revision to the inflation outlook. "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 percent medium-term target," the ECB said. "Keeping interest rates at restrictive levels will over time reduce inflation by dampening demand and will also guard against the risk of a persistent upward shift in inflation expectations."

The latest set of ECB staff macroeconomic projections, released Thursday, showed a significant upgrade to the euro area inflation outlook.

The staff now sees the headline inflation rate at 8.4 percent this year, 6.3 percent in 2023, 3.4 percent in 2024 and 2.3 percent in 2025. Core inflation, which excludes the volatile prices of food and energy, is forecast to average 3.9 percent this year and to rise to 4.2 percent in 2023, before falling to 2.8 percent in 2024 and 2.4 percent in 2025.

"The euro area economy may contract in the current quarter and the next quarter, owing to the energy crisis, high uncertainty, weakening global economic activity and tighter financing conditions," the ECB said.

The ECB staff expects "a recession would be relatively short-lived and shallow."

Eurozone growth projections wee lowered and the staff now sees the economy growing by 3.4 percent this year, 0.5 percent in 2023, 1.9 percent in 2024 and 1.8 percent in 2025. The ECB said the asset purchase programme portfolio will decline at a measured and predictable pace, and it will not reinvest all of the principal payments from maturing securities.

The decline will amount to EUR 15 billion per month on average until the end of the second quarter of 2023 and its subsequent pace will be determined over time, the bank added.