ECB Hikes Rates as Fed Expected to Take Another Pause

The European Central Bank lifted interest rates by a quarter point—the 10th consecutive hike— likely diverging from the Federal Reserve, which is expected to pause next week.

Like the Fed, the ECB has rapidly increased borrowing costs to squeeze inflation out of the economy. But unlike in the U.S., where the economy has remained resilient, the outlook for growth is gloomier in Europe—and the inflation rate is considerably higher.

The central bank for the 20 nations that share the euro has now raised interest rates by 4.5 percentage points over roughly the past year. Thursday's decision was on a knife edge–a majority of economists expected a hold, but markets priced in a hike.

The ECB hinted that it may not need to raise rates further, though it said it remains data-dependent.

"The key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target," it said in a statement with the decision.

"We are not saying that we are at peak," President Christine Lagarde said at a press conference following the decision.

Staff at the central bank published new forecasts with the decision. Predictions for inflation went up for this year and next, with the 2024 average figure coming in at 3.2%, well above the ECB's 2% target. At the same time, it said projections for growth were lowered "significantly." They now expect the euro area economy to grow 0.7% in 2023, down a previous forecast for 0.9% growth, and see 1% growth in 2024, down from an earlier 1.5% prediction.

The euro zone as a whole has avoided recession thus far, but Germany, its biggest economy, has fallen into contraction. It's not just higher interest rates that are weighing down activity. The threat of natural gas shortages after Russia's invasion of Ukraine last year is another factor. So is weakness in China, the world's second-biggest economy, on which Germany's manufacturing industry relies heavily.

At the same time, the inflation rate in the euro area stands at 5.3%, still well above the ECB's 2% target. It's down from a peak of 10.6% in October but threatens to be sticky going further.

Lagarde said that the decision to raise rates this month wasn't unanimous, but that a large majority of policy makers supported it.

The Fed announces its next decision on Sept. 20, when it is expected to hold off from further hikes and keep policy unchanged.

Write to Brian Swint at brian.swint@barrons.com