The European Central Bank increased its key interest rate by 0.5 percentage point, diverging from the Federal Reserve, and signaled it would raise rates by another half percentage point in March, as resilient economic growth in the eurozone and a rapid reopening of China’s economy are expected to keep inflation high.
The ECB’s move, its fifth large rate increase in a row, takes its key rate to 2.5%, the highest level since 2008. That is still some way below those of the Fed, which raised rates to 4.5% to 4.75% on Wednesday, and the Bank of England, which increased rates to 4% earlier Thursday.
Investors are watching closely for signs that central banks will pause their rate hikes as inflation starts to decline in a number of large economies and growth is expected to buckle, especially in the U.S.
The Bank of England raised its key interest rate Thursday for a 10th straight policy meeting, but signaled it may soon pause that series as the annual rate of inflation falls and the economy falters.
The BOE said further rate rises are possible, but only if inflation threatens to be high for longer than it currently expects it to be. The central bank had previously set a lower bar for further rate rises, but also warned that there was a large risk that a tight jobs market and big pay rises would keep inflation higher for longer than it anticipates.
“If there were to be evidence of more persistent pressures, then further tightening would be required,” the BOE said.
The central bank dropped its previously stated commitment to respond “forcefully” to “more persistent inflationary pressures,” an indication that its next move is unlikely to be larger than a quarter point.
In new forecasts, the BOE projected that the inflation rate would fall below 2% from the second quarter of 2024 if it were to raise its key rate to a high of 4.5% over coming months, as investors had expected it to in the run-up to its policy meeting. That is an indication that in the BOE’s view, the expected rate peak is likely to prove to be too high.
There was also continued resistance to further rate rises, with two of the nine policy makers voting to leave borrowing costs unchanged for the second straight meeting.
In another change in communication, those members made the most explicit reference yet to the possibility that they may soon vote for rate cuts.
The Bank of England raised rates to 4% from 3.5%.
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“As the policy setting had become increasingly restrictive, this would bring forward the point at which recent rate increases would be needed to be reversed,” they said.
Russia’s invasion of Ukraine pushed energy prices and U.K. inflation sharply higher through much of last year, but milder-than-usual temperatures, high natural-gas storage levels across Europe and a government cap started to reverse that move as 2022 drew to a close.
With energy prices set to be lower than expected when the BOE last published projections in November, the central bank lowered its inflation forecasts for coming years.
The central bank also raised its forecasts for economic growth, although it continues to expect the U.K. economy to contract this year. It now sees gross domestic product falling 0.5%, a smaller decline than the 1.5% it projected in November. That is partly because borrowing costs aren’t expected to rise by as much as they were in November, when the forecast for a deeper contraction was based on an expected rate peak of 5.25%.
The BOE had previously estimated that the U.K. economy was in recession in the second half of last year, but now sees very modest growth in the final quarter of 2022 after a contraction in the third quarter. It now expects to see a much shallower recession, lasting five quarters and starting in the three months through March.
However, even that improved forecast leaves the U.K. economy facing the sharpest slowdown among the Group of Seven wealthy democracies. The International Monetary Fund on Monday said no other G-7 member’s economy would contract this year, while even sanctions-hit Russia is expected to record modest growth.
The BOE also highlighted persistent weaknesses in the U.K. economy, lowering its estimate of the rate at which the supply of goods and services can grow to 0.7% a year from 1.5% previously. That reflects weaker investment spending since the U.K. voted to leave the European Union in 2016, a decline in the workforce as many people over 50 years of age have opted to retire or suffer long-term illnesses, and higher energy costs.
—Chelsey Dulaney contributed to this article.
Write to Paul Hannon at paul.hannon@wsj.com
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