ECB expected to hike rates to a record four per cent as central bank struggles to tame inflation

The European Central Bank (ECB) will hike interest rates to their highest level since the monetary authority of the group of countries using the euro was created in 1999, markets are betting.

President Christine Lagarde and the rest of the governing council, Europe’s equivalent to the Bank of England’s monetary policy committee, are poised to kick borrowing costs to a peak of four per cent to tame steaming inflation.

Prices have surged across the 20 countries using the common currency, pushed higher by Russia’s invasion of Ukraine roiling international energy markets.

That upward price drive has prompted the ECB to hoist rates five times in a row to 2.5 per cent, already the steepest level since the financial crisis. Rates had actually been negative for several years.

However, a batch of numbers out today on French and Spanish inflation indicate the initial energy price surge is seeping into other sectors of respective euro area economies.

“Somewhat surprisingly the increase in [France’s] headline rate was not driven by higher energy inflation,” Melanie Debono, senior Europe economist at Pantheon Macroeconomics, said.

“The energy rate eased to 14.6 per cent from 16.3 per cent in January as base effects and the fall in wholesale energy prices and fuel products offset the impact from the rise in the electricity price cap this month,” she added.

Instead, rampant food price rises led France’s, Europe’s second largest economy, overall inflation to 6.2 per cent annually in February, above the consensus forecast and up from six per cent in January.

Spain’s inflation rate also bumped higher to 6.1 per cent from 5.9 per cent over the same period, shocking analysts.

The stronger than expected figures triggered markets to raise their peak interest rate expectations to four per cent from 3.75 per cent. The euro also strengthened against the US dollar.      

Across the entire euro area, prices rose 8.6 per cent over the year to January, down from December’s more than nine per cent rate, but today’s French and Spanish numbers open the door for inflation in the entire bloc staying higher for longer.

At the beginning of the year, investors reckoned central banks were nearing the end of their rate hike campaigns for fear of dealing too much damage to their respective economies.

However, a series of hotter data in the US, UK and Europe has indicated spending is withstanding aggressive rate increases, raising the risk of elevated inflation sticking around.

While the US Federal Reserve and Bank of England will probably launch one or two more smaller rate rises, the ECB is far from done, with Lagarde repeating commitments to continue to tighten financial conditions by 50 basis points a few more times this year.

Today’s French and Spanish inflation numbers “suggest the ECB is right to stay on its steep tightening path for now,” Debono added.

Its next rate decision is on 16 March.