This is the first time since 2011 that the ECB has raised rates and returned the main European rate to zero. Rates in the region have been negative since 2014.
The central bank had previously indicated it would hike rates by a smaller margin, but decided it needed to be more aggressive based on an “updated inflation risk assessment.”
“Inflation remains undesirably high and is expected to remain above our target for some time to come,” ECB President Christine Lagarde said at a press conference.
The central bank has declined to stick to a definitive rate hike path going forward, seeking to keep its options open.
“From now on, we will make data-driven monetary policy decisions,” Lagarde said. “We will work month after month and step by step. What happens in September will depend on what data we have for September.”
The ECB also introduced a new bond-buying tool designed to contain the cost of borrowing in heavily indebted eurozone countries such as Italy and Greece. The central bank wants to maintain cohesion within the region using the single currency.
The central bank said the so-called Transmission Protection Instrument “could be activated to counter unreasonable, erratic market dynamics that pose a serious threat to the spread of monetary policy in the euro area.”
The European Central Bank stands ready to deploy this tool if necessary, provided that countries meet certain indicators of fiscal and economic health, Lagarde stressed.
“I can assure you that we would prefer not to use TPI,” she said. “But if we have to use it, we won’t hesitate.”
A weak currency exacerbates the inflation problem, as it means European companies have to pay more for imports, including for energy.
The ECB has an uphill climb as it ramps up efforts to stem the rapid rise in prices. While the summer tourist season, pandemic-era savings and a resilient labor market continue to support the European economy, growth is slowing.
The central bank is not yet preparing for a recession. The company said in June that it expects production to increase by 2.8% this year and 2.1% in 2023.
“In the baseline scenario, there will be no recession this year or anytime soon,” Lagarde said on Thursday, although she acknowledged that the horizon is “cloudy.”
Recession risks could limit the ECB’s ability to keep raising interest rates, which helps fight inflation but also slows down the economy.
The ECB is already far behind its peers. After cutting rates to zero at the start of the pandemic, the Fed has hiked its benchmark rate sharply since March, raising its benchmark rate sharply over the past few months to combat runaway inflation. Only the Bank of Japan, which was ultra-soft on Thursday, did not budge.
It also has to deal with a high degree of uncertainty about energy supply, which makes forecasting future inflation difficult.
Russia’s Gazprom resumed gas supplies via the critical Nord Stream 1 gas pipeline on Thursday, easing fears that it would not resume operation after a period of scheduled maintenance. But it is not operating at full capacity, and fears remain that Russia may at some point cut off gas supplies in retaliation for Western sanctions.