Europe’s central bank halts rate hikes as Israel-Hamas war casts a shadow over the economy

The European Central Bank (ECB) has decided to leave interest rates unchanged for the first time in over a year as the Israel-Hamas war spreads even more gloom over already downbeat prospects for Europe’s economy.

This is the bank’s first meeting with no change after a torrid pace of 10 straight increases dating to July 2022 that pushed its key rate to a record-high 4%. The ECB would join the US Federal Reserve, Bank of England and others in holding borrowing costs steady — albeit at the highest levels in years — as inflation has eased.

In Europe, inflation peaked at a painful 10.6% in October for the 20 countries that use the euro currency as Russia’s full-scale invasion of Ukraine took a toll. Those high prices have been poison for consumer spending, draining household finances with added costs for necessities such as food, heat and electricity.

But with inflation now down to 4.3%, analysts predicted that the ECB would hold off on more hikes during its meeting in Athens. It is one of the bank’s regular meetings away from its Frankfurt headquarters, meant to underline its status as a European Union institution.

Mathieu Savary, chief European strategist at BCA Research, told Euronews that the ECB’s decision to hold firm on interest rates shows that the central bank is “comforted” by the recent slow-down of inflation.

“Nonetheless, inflation remains elevated enough that the [ECB’s] Governing Council could not let its guard down completely, especially in light of the ECB’s large balance sheet,” he added.

Now, worries are sharpening about weakening economic growth and even the risk of a recession. Rate hikes are a central bank’s chief weapon against inflation, but they can weigh on economic growth by raising the cost of credit for consumer purchases, particularly homes, and for companies to buy new equipment and facilities.

Surveys of purchasing managers by S&P Global indicate that economic activity fell in October. Analysts at ABN Amro bank foresee a 0.1% drop in economic output in the eurozone for the July-September quarter and minus 0.2% for the last three months of the year. The EU will publish third-quarter figures on Tuesday.

Inflation’s impact on consumers was a big reason why Europe has seen almost no growth this year, recording zero in the first quarter and 0.2% in the second. Its biggest economy, Germany, is forecast by the International Monetary Fund to shrink by 0.5% this year, making it the world’s worst-performing major economy. The IMF says that even Russia is expected to grow this year.

And there’s little prospect of improvement for Europe this year. The Israel-Hamas war adds uncertainty because Europe is heavily dependent on imported energy, which could be affected if the war widens to include Iran or its proxy fighters in Arab countries.

“The ECB won’t be in any rush to take further action,” said Carsten Brzeski, global head of macro at ING bank. “Instead, it will use a welcome pause to wait for more data points on the delayed impact of the rate hikes so far and developments in the oil price.”

The emphasis has shifted to how long rates will stay at record highs. ECB President Christine Lagarde has repeated the bank’s message that rates have now “reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation” to its goal of 2% considered best for the economy.

That was taken as a signal the ECB was finished raising rates, though some analysts aren’t ruling out a last rate hike in December if the expected decline in inflation doesn’t materialise.