Economic Highlights

• The ECB raises its interest rate by 75bps, the first rate hike of such magnitude on record. This signals how serious the central bank is in getting inflation in the region back to its mediumterm target at 2%.

• Accordingly, the interest rate on the main refinancing operations, that of the marginal lending facility, and the deposit facility will be increased to 1.25%, 1.50% and 0.75%, respectively.

ECB – Hikes Key Interest Rate by a Record 75bps

The European Central Bank (ECB) hiked its interest rate by 75 basis points (bps) yesterday, the first rate hike of such magnitude on record. This signals how serious the central bank is in getting inflation in the region back to its medium-term target at 2%.

Accordingly, the interest rate on the main refinancing operations, that of the marginal lending facility, and the deposit facility will be increased to 1.25%, 1.50% and 0.75%, respectively.

The euro remained weak as it closed below parity at 0.9997. It made some gains early in the session but these were immediately erased after the rate hike announcement. It dropped by as much as 0.93% from 1.0028.

Based on this latest decision, we expect the ECB will continue raising its interest rates for the remainder of the year to dampen demand, anchoring the inflation expectation. The ECB seemed to be following the US Fed’s move in frontloading the rate normalization as it acknowledged that the runaway inflation is already at dangerous level and will stay there for longer.

As such, the ECB has revised its inflation projection to average at 8.1% in 2022, and 5.5% in 2023, up from the previous projection of 6.8% and 3.5%, respectively. With Russian gas supplies to Europe cut off indefinitely, we are unclear if the inflation rate will reach the projected level or even going beyond the projection.

Another thing to note is that the temporary abandonment of the rate forward guidance and switching to the “meeting-by-meeting” approach, which is data dependent, provides the ECB the flexibility to adjust its monetary policy amidst highly uncertain environment.

All in all, there are possibilities that the ECB’s key rates will be raised by at least another 75bps. We think it is necessary for the central bank to opt for such a steep policy move amidst the limited options they have. Nevertheless, it is risky for the ECB to ramp up its interest rate during an economic downturn which could worsen the current cost-of-living crisis.

Source: AmInvest Research - 9 Sept 2022