- On Thursday, the European Central Bank (ECB) raised its key interest rate from 3.75% to 4% as it claimed inflation was 'expected to remain too high for too long.'1
- The decision was the 10th interest rate increase in a row, reaching an all-time high since the establishment of the euro in 1999. It follows the ECB's benchmark deposit rate of -0.5% a little more than a year ago.2
- Alongside the benchmark deposit rate, the ECB's refinancing rate, which provides most of the liquidity to the banking system, increased from 4.25% to 4.5%. Its marginal lending facility, which is charged when banks borrow from the ECB, also climbed from 4.5% to 4.75%.3
- The ECB stated that, based on its assessments, current interest rate levels are to make a 'substantial contribution' to the 'timely return' of inflation to its target levels.4
- Revised forecasts for average inflation within the eurozone now stand at 5.6% for 2023, 3.2% for 2024, and 2.1% for 2025. The ECB also projected the euro zone's economy to grow by 0.7% this year.4
- Core inflation within the eurozone stood at 5.3% in August, while business activity within the bloc declined in August to its lowest level since November 2020. Germany, the group's largest economy, is also forecast as the only major European state to contract this year.5
- Narrative A, as provided by Bloomberg. The ECB's decision-making has led to many European policymakers finding themselves in a precarious economic situation. Revised forecasts are extremely optimistic, while the bank's vision echoes similar choices made in 2011 that ultimately caused a severe economic downturn within the eurozone. The ECB may well be, slowly but surely, walking into a stagflationary trap.
- Narrative B, as provided by Fxstreet. The ECB has chosen to accept a period of stagflation over the danger of a hard landing and deeper recession. The lesser of two evils, the market's overreaction to the ECB's decision-making is a shocking one that may well be counteracted by the US' own release of data in the coming days.