The European Central Bank raised its key rates by an unprecedented 75 basis points, signaling that further hikes are likely.
On Thursday afternoon, the bank raised the deposit rate from zero to 0.75% and the main refinancing rate was raised to 1.25%, their highest level since 2011.
It comes as the bank battles inflation at its highest level in half a century and the bloc heads into a likely winter recession.
In a statement, the ECB said: “Over the next few meetings, the Governing Council plans to raise interest rates further to dampen demand and hedge against the risk of a persistent rise in inflation expectations. “
The bank has revised its economic forecast, forecasting average inflation of 8.1% this year, 5.5% in 2023 and 2.3% in 2024.
Inflation was initially driven by energy prices – exacerbated by the Russian invasion of Ukraine – but is also fueled by the drought seen in recent months.
The ECB said: “Price pressures have continued to build and spread across the economy and inflation could rise further in the near term.
“This major step precipitates the transition from the very accommodative level of policy rates to levels that will ensure the rapid return of inflation to the ECB’s medium-term target of 2%.”
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The ECB forecast GDP growth of 3.1% this year, up from the 2.8% projection it made in June, but it cut its forecast for 2023 from 2.1% to 0.9%.
Rob Clarry, investment strategist at Evelyn Partners, said: “While eurozone inflation was largely driven by supply-side challenges rather than excessive demand, the ECB acted decisively in seeking to prevent expectations of higher inflation from taking root.
“Another crucial reason is to try to stop the decline of the euro against the US dollar as this has put additional upward pressure on inflation.
“Basically, it looks like the ECB is taking a position similar to that of the Bank of England and the Federal Reserve: fighting inflation at the expense of economic growth.
“Although the economic outlook looks challenging, there are some positives we can take advantage of.
“First, the euro area has made good progress in rebuilding its gas stocks before winter; whether this will be sufficient will depend on ongoing flows and winter weather conditions.
“Second, there seems to be an emerging consensus in the bloc that governments need to support households by subsidizing energy bills.
“Indeed, this week we have seen Germany (65 billion euros), Portugal (2.4 billion euros) and the Netherlands (16 billion euros) announce support plans.
“This should support consumer spending as the eurozone seeks to avoid a prolonged economic contraction.”
