More expensive loans for citizens and companies in the eurozone

The European Central Bank raised interest rates today for the first time in almost three years, hoping to curb inflation before a surge in energy prices caused by the Iran war spills over into the wider eurozone economy.

The deposit rate was increased from 2,00 to 2,25 percent, the main refinancing rate from 2,15 to 2,40 percent, and the marginal lending rate from 2,40 to 2,65 percent. The ECB sets monetary policy for the eurozone through these three key interest rates, with the deposit rate serving as the main benchmark for its policy.

For households and companies across the 21-country bloc, the decision means higher borrowing costs for housing and corporate loans, at a time when purchasing power is already being squeezed by high fuel and gas prices, Euronews reports.

The ECB's deposit rate was last increased in September 2023, when it peaked at four percent after a cycle of monetary policy tightening aimed at stabilizing the inflationary crisis following the pandemic.

The ECB's decision to hike rates is the first response by one of the world's major central banks to an energy shock. It comes a week before the US Federal Reserve, the Bank of Japan, the Bank of England and several other leading institutions are due to make monetary policy decisions.

The ECB's move, which was expected, comes at a time when inflation in the 21-country eurozone is already above three percent, well above the ECB's two percent target, while economic growth is very weak - leaving economists divided on whether further policy tightening is needed.

The decision, which was accompanied by higher inflation projections for this and next year, but also weaker growth forecasts, was made unanimously.

"The war in the Middle East is creating inflationary pressures, and the decision to raise rates is firmly grounded in a range of scenarios that show how this shock could unfold," ECB President Christine Lagarde said in an introductory statement.

However, the prevailing view in the ECB is that there will be no new interest rate hike in July unless energy prices continue to rise.

However, they remain open to further tightening, possibly as early as September, partly because the bank's own new projections are based on the assumption of further tightening of monetary policy, two sources told Reuters.

Economists had expected today's move, saying it was primarily designed to keep inflation expectations under control and protect the ECB's credibility, after it was slow to respond to the post-pandemic inflation spike in 2022.

Several analysts who follow the ECB called it a “precautionary hike” - a precautionary measure that could be reversed if price pressures weaken.

Lagarde, however, rejected such an interpretation, saying that the increase was an "obvious" decision that would remain in effect even in a "milder" scenario in which inflation falls below two percent by spring next year.

ING's global head of macroeconomics, Karsten Brzeski, said Lagarde's comments indicated that further tightening was coming.

"The warning that inflationary pressures are spreading, as well as the emphasis on the increasingly pronounced indirect effects of higher energy prices, suggest that today's rate hike is not the end yet," Brzeski said.

Not all economists are convinced that the increase is justified: some warn that the ECB risks further tightening policy on an economy that is already paying a high price for the conflict in Iran.

Paul Donovan, chief economist at UBS Global Wealth Management, said the ECB was making a “mistake” and was stuck in an “unhelpful 2022 mindset,” alluding to the inflation recovery that followed the Covid lockdown.

A Reuters analysis of conference call transcripts from eurozone companies showed that only 40% of firms outside the financial sector had raised prices or planned to do so, about half as many as in 2022, when the war in Ukraine pushed up energy prices.