The European Central Bank (ECB) has once again raised interest rates by 0.5 percentage points, bringing the interest rate paid on bank deposits to three percent.
The ECB justified the interest rate hike due to persistently high inflation in an uncertain environment, necessitating a data-driven approach. The central bank stated that it is closely monitoring current market tensions and is prepared to take necessary measures to maintain price and financial stability in the euro area.
“The euro area banking sector is resilient and capital and liquidity positions are strong. In any case, the ECB has all the monetary policy tools at its disposal to provide liquidity support to the euro area financial system if necessary and to ensure the smooth transmission of monetary policy,” the central bank noted.
In recent weeks, several analysts have questioned whether the ECB would raise interest rates by the previously speculated 0.5 percentage points on Thursday, due to recent banking crises in the US and Europe. With Thursday’s decision, the main refinancing rate will be 3.5 percent, the borrowing facility rate will be 3.75 percent, and the deposit facility rate will be three percent from March 22.
The ECB’s experts completed their new macroeconomic projections at the beginning of March before the recent tensions emerged in financial markets. These tensions may bring additional uncertainty to inflation and growth forecasts, the central bank said.
Prior to recent trends, the ECB’s experts had already revised down their main inflation projections, primarily due to energy prices having a smaller impact than expected. According to the ECB’s experts, inflation is expected to be 5.3 percent in 2023, 2.9 percent in 2024, and 2.1 percent in 2025. However, price pressure remains strong.
Excluding energy and food components, inflation accelerated in February. According to the ECB’s experts, inflation is expected to average 4.6 percent in 2023, which is faster than previously forecast in December. Inflation is then expected to slow to 2.5 percent in 2024 and 2.2 percent in 2025 as previous supply shocks and the reopening of the economy diminish, and tighter monetary policy increasingly suppresses demand.
The ECB will also reduce the volume of its asset purchase program, as the Eurosystem will no longer reinvest all principal payments received on securities that have matured. The reduction will average 15 billion euros per month until the end of June 2023, and its further scope will be determined over time.
The ECB also intends to reinvest principal payments received on securities purchased under the pandemic emergency purchase program until at least the end of 2024. In any case, the ECB will manage the eventual liquidation of the pandemic emergency purchase program to avoid interfering with its appropriate monetary policy course.
While banks repay funds borrowed through targeted longer-term refinancing operations, the ECB regularly assesses how these operations support its monetary policy stance.
The ECB stands ready to adjust all its monetary policy instruments within its mandate to ensure a medium-term return of inflation to its two percent target and the smooth transmission of monetary policy. The central bank has all the monetary policy tools at its disposal to provide liquidity support to the euro area financial system if necessary.
Additionally, a monetary policy transmission protection instrument (TPI) has been created to contain unjustified and excessive market dynamics that pose a serious threat to the transmission of monetary policy throughout the euro area. This instrument enables the ECB to more effectively achieve its price stability objective.
The European Central Bank’s decision to raise interest rates and reduce its asset purchase program reflects its commitment to maintaining financial stability amidst persistently high inflation and uncertain market conditions. The bank’s willingness to adjust its monetary policy tools and assess the impact of its targeted longer-term refinancing operations demonstrates its proactive approach to supporting the euro area financial system.