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08 Sep
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The E.C.B. Fights Inflation With Big Rate Increase

The European Central Bank raised interest rates sharply on Thursday as policymakers battle to bring down record high inflation driven by soaring energy prices, but it warned of an economic slowdown ahead.

The bank increased its three key rates by three-quarters of a percentage point, the biggest rise since 1999, in the very early days of the eurozone. Around the world, central banks have been pushing rates higher in larger increments to send strong signals to consumers and businesses that they will bring inflation back to their targets.

Policymakers in Europe are facing a particularly difficult economic challenge, fighting high prices in the face of growing expectations that the energy crisis — rising prices and the looming prospect of steep cutbacks and even rationing of gas this winter — could cause a recession in Europe.

The bank said it expected to see a “substantial slowdown” in growth in the 19 countries using the euro, “with the economy expected to stagnate later in the year and in the first quarter of 2023.” Projections for economic growth for the remainder of the year and into the next were scaled back.

The bank’s staff has now raised its inflation forecast to average 8.1 percent this year but then ease to 5.5 percent in 2023 and 2.3 percent in 2024.

With high energy prices continuing to weigh on businesses and individual households, policymakers expect “to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations,” the bank’s statement said. Since the last policy meeting, the eurozone’s annual inflation rate rose to 9.1 percent in August, up from 8.9 percent the previous month. The central bank targets a medium-term inflation rate of 2 percent.

Given the persistence of inflation, “forceful action is thus inevitable, with no room for prudence,” Anatoli Annenkov, an economist at Société Générale, wrote in a note to clients last week.

With inflation in the eurozone ranging from 6.5 percent in France to 25.2 percent in Estonia, and the region’s economic outlook deteriorating because of the exceedingly high price of energy, the bank’s statement confirmed assumptions that more interest rate increases are ahead. Some policymakers have argued that keeping inflation expectations low requires strong action, especially because there is so much uncertainty about the future path of prices.

Others have said an economic slowdown shouldn’t stand in the way of tackling inflation with higher rates.

“Both the likelihood and the cost of current high inflation becoming entrenched in expectations are uncomfortably high,” Isabel Schnabel, a member of the bank’s executive board, said at the end of last month. “In this environment, central banks need to act forcefully.”

Still, some other policymakers have suggested that an economic slowdown will weaken inflationary pressures and the bank won’t have to respond as aggressively. The bank’s chief economist, Philip Lane, has advocated a “steady” approach to rate increases.

The E.C.B. was one of the last major central banks to raise interest rates to tackle inflation, but Thursday’s move showed it had understood the need to move more forcefully. But markets initially shrugged off the move and the euro, after a brief jump, remained flat.

First, it ended its massive bond-buying programs but policymakers held back on raising interest rates amid the uncertainty of the economic impact of the war in Ukraine. With much of the price increases in the eurozone driven by energy and other internationally traded goods, the central bank had previously expected inflation to slow quickly once these shocks faded. Now, it is raising interest rates in an effort to “normalize” the policy stance, without it becoming restrictive and slowing the economy. In comparison, the Federal Reserve has been quickly and steeply raising interest rates to slow demand in an overheating economy.

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