ECB Maintains High Interest Rates to Combat Inflation Amid Economic Slowdown
The European Central Bank (ECB) is determined to keep interest rates high enough to restrict business activity "as long as necessary" to counter inflation, according to the bank's president, Christine Lagarde. Speaking on Monday, she noted that the upward pressure on prices remains robust in the eurozone due to factors such as strong spending on holidays and travel and increasing wages.
Annual inflation in the eurozone decreased slightly from 5.2% in July to 5.3% in August. Despite this slight drop, Lagarde emphasized that inflation is still expected to remain too high for too long. She reiterated the ECB's commitment to bringing inflation back to its 2% medium-term target promptly.
In response to the persistent inflation, the ECB recently increased its benchmark deposit rate to an all-time high of 4%, up from -0.5% in July 2022. This move came despite signs of increasing weakness in the European economy. Other central banks, including the Bank of England and the U.S. Federal Reserve, refrained from rate hikes last week as they approach the end of their rapid rate-increase campaigns.
Inflation surged as the global economy recovered from the COVID-19 pandemic, leading to supply chain disruptions. The situation was exacerbated when Russia invaded Ukraine, causing energy and food prices to skyrocket.
Lagarde believes that interest rates are now at a level where they can make a substantial contribution to reducing inflation if maintained for a sufficiently long duration. The ECB projects inflation will decline to an average of 2.1% in 2025 after peaking at a record-high 10.6% in October.
The ECB's higher rates have led to a significant slowdown in real estate transactions and construction, sectors highly sensitive to credit costs, effectively ending a prolonged rally in eurozone home prices.
The European economy broadly stagnated in the first half of this year, with incoming data indicating further weakness in the July-to-September quarter. However, Lagarde cited ECB forecasts anticipating an economic recovery as inflation decreases, which would provide consumers with more purchasing power.
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