European Central Bank Surprises Markets with Bigger Than Expected Hike

The European Central Bank on Thursday surprised markets with a bigger than expected increase in its benchmark deposit rate, hiking by 50 basis points.

This is the first time in 11 years that the ECB has increased interest rates. Traders had been expecting a smaller increase of 25 basis points. A basis point is one-hundredth of a percentage point, so a 50 basis point hike is half a percentage point.

The Frankfurt-based ECB is the central bank of the 19 nations that use the euro as their currency.

“The Governing Council judged that it is appropriate to take a larger first step on its policy rate normalisation path than signalled at its previous meeting,” the ECB said in a statement Thursday.

The ECB’s deposit rate target had been negative. After the hike, it is now targeting zero for its deposit rate.

“Inflation continues to be undesirably high and is expected to remain above our target for some time. The latest data indicate a slowdown in growth, clouding the outlook for the second half of 2022 and beyond,” ECB President Christine Lagarde said following the announcement.

The euro rose on the news of the more aggressive hike. The euro has lost value against the dollar for months as global investors thought the ECB had fallen behind the Federal Reserve in acting on inflation. Investors are also worried about Europe’s economies suffering deeper recessions than the U.S., in part because so many European countries are vulnerable to Russian energy supplies.

Just like the Fed, the ECB targets two percent inflation.  Last month, inflation in the eurozone hit a record high of 8.6 percent.

In addition to the deposit rate, the ECB deploys a “refinancing rate” for funds available to banks from the central when they are short on liquidities. This was raised to 0.5 percent. The marginal lending facility, which banks can tap to meet overnight reserve requirements, was raised to 0.75 percent.

The ECB affirmed that it sees more hikes ahead.

“At the Governing Council’s upcoming meetings, further normalisation of interest rates will be appropriate. The frontloading today of the exit from negative interest rates allows the Governing Council to make a transition to a meeting-by-meeting approach to interest rate decisions,” the ECB said.