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ECB announces interest rate hike of 0.25 points

ECB announces interest rate hike of 0.25 points
Written by insideindyhomes

Status: 09.06.2022 7:13 p.m

The European Central Bank ended its bond purchases – the prelude to the interest rate turnaround that many were longing for. In July it wants to raise its key interest rate by 0.25 percentage points. It’s the first increase in over a decade.

After many years of ultra-loose monetary policy, the European Central Bank (ECB) will end its multi-billion dollar net bond purchases on July 1, paving the way for the first interest rate hike in the euro area since 2011. The Governing Council decided this today at its off-site meeting in Amsterdam , as announced by the central bank.

At the next meeting in July, key interest rates are to be raised by 25 basis points. “The decision was approved unanimously,” said ECB President Christine Lagarde. “We had a very productive discussion.” In September, Europe’s currency watchdogs are likely to step up their game – even more so than in July if inflation remains high. The prerequisite for this is that the in-house forecasts see the inflation rate in 2024 at 2.1 percent or higher.

Initially, however, the official key interest rate – the so-called main refinancing rate – will remain at the record low of zero percent. In addition, banks must continue to pay the deposit rate of 0.5 percent for parked funds at the ECB.

A turnaround in interest rates had already been indicated

As early as May, leading ECB representatives such as the most important German representative on the central bank council, Isabel Schnabel, had hinted at a turnaround in interest rates. Lagarde also announced last month that the purchase of new securities should end “very early” in the third quarter and that the era of negative key interest rates should be history relatively quickly thereafter.

In the course of the global financial crisis, the sovereign debt crisis surrounding Greece and later in the corona pandemic, the ECB was in emergency mode for years. Its extremely loose monetary policy led to historically low interest rates of zero percent and bond purchases in the billions in 2016.

ECB initiates about-face in its interest rate policy

Klaus-Rainer Jackisch, HR, daily news at 8:00 p.m., June 9, 2022

Since 2015, the central bank has been buying government and corporate bonds, pumping huge sums into the system to keep the economy afloat in times of crisis and fuel inflation. The ECB is actually aiming for an inflation rate of two percent as the ideal value for the economy. For years, inflation was far too low from the central bank’s point of view. ECB President Christine Lagarde described the development of the corona pandemic as only a temporary phenomenon.

Record inflation of more than eight percent

In the meantime, however, the picture has changed radically. Fueled by the Ukraine war and the associated high energy prices, inflation in the euro area recently rose to a record 8.1 percent. It was around four times higher than the medium-term price target. Because food and many raw materials as well as preliminary products for industry have also become significantly more expensive.

The ECB is lagging behind many other central banks in tightening monetary policy. In the USA and Great Britain, interest rates were raised significantly months ago. Critics repeatedly accuse the European monetary authorities of acting much too slowly.

Because the important deposit rate remains at minus 0.5 percent, commercial banks still have to pay penalty interest if they park excess funds at the ECB. This is often given to bank customers as a justification for negative interest rates.

Tightening pace a sensitive issue

So far, there has been little opposition to Lagarde’s line from the ranks of the ECB. However, there are debates in detail: On the one hand, the pace of interest rate tightening seems to be the subject of heated debate in the Monetary Policy Council. So-called “hawks”, ie supporters of a tighter monetary policy like the head of the Austrian central bank, Robert Holzmann, are calling for rapid tightening with larger interest rate hikes. The more cautious “doves” are in favor of a “gradual” course with smaller steps because of the economic uncertainty caused by the Ukraine war. On the financial markets, a large increase in interest rates by a total of 0.5 percentage points is currently expected in the current year.

It is also unclear which interest rate level the central bank is targeting. The decisive factor is the level of the “natural” interest rate, a kind of inflation- and growth-neutral interest rate. For the USA, this neutral interest rate is currently estimated at around 2.5 percent. In the euro zone, it is likely to be lower, partly because of much lower core inflation. The ECB central bankers do not agree on this issue either.

ECB in a dilemma

On the one hand, higher interest rates make the euro more attractive for investors, which can boost its rate and thus make imports of raw materials and energy cheaper. On the other hand, they make loans more expensive, which dampens consumption, investment and thus demand. According to economic theory, both lead to a limitation of inflation.

ECB President Lagarde, however, dampened hopes of a rapid decline in inflation in the euro area as a result of the interest rate turnaround that has now been announced. “Do we expect the rate hike in July to have an immediate impact on inflation? The answer is no,” she said after today’s meeting. “It’s not a step, it’s a journey.”

At the same time, the already ailing economy – which is suffering from the consequences of the pandemic, the Russian war against Ukraine and material shortages – threatens to suffer another setback. A rise in interest rates will also make borrowing more expensive for the euro countries, which is likely to put a strain on the budgets of heavily indebted countries such as Greece and Italy in particular.

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