ECB Hikes Its Key Rate And Warns Of Darkening Outlook

ECB Hikes Its Key Rate And Warns Of Darkening Outlook
Luke Suddards

about 1 year ago2 mins

What just happened?

The European Central Bank (ECB) hiked its key interest rate by 0.5 percentage points as expected, but what caught investors off-guard was its aggressive language, warning that rates would still need to rise “significantly at a steady pace” in the next year, to beat back the euro zone’s stubbornly high inflation. Many had been forecasting a gentler approach.

The ECB said it expects inflation to still be at 3.4% at the end of 2024, well higher than the central bank’s 2% long-term target and higher than the 2.3% it had been forecasting earlier this year. (Inflation was at a red-hot 10% in November.) The outlook isn’t better from an economic growth standpoint: the ECB has revised its forecast lower, expecting just 0.5% growth in 2023, down from 0.9%.

The ECB also said it will step up its efforts to unload its balance sheet, beginning a process known as quantitative tightening. Specifically, the Bank said it would shrink the number of maturing bonds that it reinvests in, at an average pace of €15 billion ($16 billion) per month, beginning in March.

In a news conference after the interest rate decision, ECB chief Christine Lagarde pulled no punches, saying the ECB was playing a “long game” against inflation and saying rates would go higher than investors were currently betting on. So, investors adjusted their thinking, quickly. They now see the ECB’s key rate eventually peaking around 3.08%, from 2.81% just before the announcement.

What does it mean?

Things are about to get a whole lot tougher for the euro zone economy as the ECB tries to stamp out inflation with their interest rate hikes. And that will make things harder for the global economy, the US, China, and the UK not expecting great growth either.

Why should you care?

This is a warning sign flashing for markets – proceed with caution. European equity markets like the DAX and Euro Stoxx 50 tumbled almost 2% after the announcement, as it seemed to sound yet another death knell for the near-zero interest rates that contributed to stocks’ headier days. Over in bond land, the BTP Bund spread, which is the closely watched difference in yield between Italian and German bonds, surged above the key 2% threshold, indicating angst amongst investors. The takeaway is that it may be time to start thinking more defensively about your portfolio. Remember bulls can make money, bears can make money, but pigs get slaughtered.

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