ECB Hikes Interest Rates To Their Highest Level Since 2001

ECB Hikes Interest Rates To Their Highest Level Since 2001
Stéphane Renevier, CFA

6 months ago2 mins

What just happened?

The European Central Bank (ECB) just hiked interest rates by a quarter of a percentage point, bringing the bloc’s key rate to a whopping 3.5% – a high we haven't seen since 2001. The ECB isn't being coy about things either, warning that this rate-hike saga may continue through the summer.

The ECB also said it’ll put an end to reinvestments in its bond-buying program next month, which had been keeping interest rates on the lower side and liquidity on the higher side. And in case you thought there was going to be a sliver of optimism from Europe’s monetary authority, there wasn’t: the Bank also revised down its macroeconomic outlook, forecasting higher inflation and lower economic growth.

That’s going to make it hard to get excited about the investing prospects for the region. But, on the bright side, most of this was what investors had expected. So the market mostly took this news in its stride.

What does it mean for markets?

The inflation dragon is under attack in much of the world as central banks get closer to slaying it with some aggressive interest-rate increases. But it’s not going down without a fight: the “core” measure of inflation, the one that excludes the more volatile food and energy prices, is still stubbornly hot. And that suggests that we could see a few more rate hikes on the horizon.

Thursday’s hike from the ECB is in line with the pattern we've been seeing in the past few weeks. Central banks in Australia and Canada both resumed rate increases this month, having previously hit the pause button, and that caught a lot of investors a bit off guard. And the US Federal Reserve echoed a similar tune on Wednesday – pausing its 10-hike rate cycle, but warning that additional rate hikes will likely be on the table before the year bows out.

Why should you care?

The economy's been flexing its muscles alright, but so has core inflation, and that’s especially true in Europe. This means that more rate hikes might be needed to cool that core level, and that investors longing for rate cuts might have to play the waiting game, even if the economy really hits the brakes.

And sure, despite a few bad blows, the financial system's mostly taken these interest rate hikes like a champ so far. But even champs falter under prolonged pressure. With rates at these elevated levels, the risk of a financial hiccup grows. And that kind of thing could very well happen right when the effects of all those rate hikes start to really pinch the economy. In fact, bond investors in the US and Europe are banking on it, as inverted yield curves reflect the expectations that those economies aren’t likely to avoid a recession.

So it’s an incredibly delicate balance between inflation weakening and growth remaining strong. Prepare yourself, because this roller-coaster ride won’t likely get any smoother in the coming months.



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