The European Central Bank (ECB) resumed interest rate hikes for the first time in about three years, responding to inflation stemming from the U.S.-Iran war. It becomes the first among major central banks to begin tightening. Japan, facing a rate decision next week, and Australia, which has raised rates three times this year, are also likely to make additional hikes within the year. With the U.S. Federal Reserve (Fed) now seen as certain to hold rates rather than cut them through the end of this year, a global domino of tightening is taking shape.
According to Bloomberg on Wednesday, the ECB held a monetary policy meeting in Frankfurt, Germany, that day and raised its three key policy rates by 25 basis points (bp, 1 bp = 0.01 percentage point) each. As a result, the deposit rate rises to 2.25 percent, the main refinancing rate to 2.40 percent, and the marginal lending rate to 2.65 percent. The ECB's rate hike marks the first in two years and nine months since September 2023.
Ahead of this meeting, hawkish views emerged within the ECB. Yannis Stournaras, governor of the Bank of Greece, said in a recent interview that "a rate hike is the most likely outcome at the June meeting." Gediminas Šimkus, governor of the Bank of Lithuania, also said that "we should not surprise the market by making no decision at all." In a recent Reuters survey of 80 economists, 74 (92.5 percent) expected the ECB to raise rates.
The ECB's rate hike was driven by the surge in energy prices, which have hovered around $100 per barrel due to the U.S.-Iran war, intensifying upward pressure on prices. The eurozone is a major energy-importing region and is seen as particularly vulnerable to shocks originating in the Middle East. Indeed, the eurozone's April consumer price index (CPI) rose 3.2 percent year-on-year, far exceeding the ECB's 2 percent target. Energy prices jumped 10.9 percent from a year earlier. The market expects two to three additional hikes over the next year.
Other countries caught up in oil-driven inflation have also turned hawkish. The Bank of Japan is expected to hold its monetary policy meeting on the 16th of this month and raise the rate from the current 0.75 percent to 1.0 percent. This would mark entry into the 1 percent range for the first time in some 30 years since September 1995. The Bank of Japan also sees the risk of rising prices from turmoil in the Middle East as greater than the possibility of a recession.
The Reserve Bank of Australia, which holds its meeting the same day, is expected to keep the rate at 4.35 percent, but market experts predict it will raise the rate by 25 bp to 4.7 percent as early as August. Australia has already taken baby steps of 25 bp each three times, on February 3, March 17, and May 5. Bank of Canada Governor Tiff Macklem, after holding the rate at 2.25 percent on the 10th, signaled concern over tightening, saying that "the simultaneous occurrence of economic weakness and inflation is a dilemma for monetary policy."
The U.S. Fed has shifted its stance from a rate cut within the year toward holding. This reflects worsening inflation, with the U.S. May CPI rising 4.2 percent year-on-year, the highest in three years and one month. The May producer price index (PPI) also rose 6.5 percent from a year earlier, exceeding both the previous reading (6.0 percent) and the forecast (6.4 percent). Strong employment, with U.S. nonfarm payrolls in May totaling 172,000, more than double the forecast, is also a factor lowering the likelihood of a rate cut.
Goldman Sachs, which last month pushed back its forecast for the Fed's first rate cut from September to December, recently abandoned the prospect of a cut this year and pointed to June next year. Bank of America (BofA) projected that the Fed would keep rates at the current level this year and cut only in July next year. Reuters reported that in its own survey of 102 economists, 72 expected the Fed to leave rates unchanged through the end of the year.
