Hi Daan, what exactly does this ECB rate hike mean?
‘It’s about the deposit rate, the interest that banks have to pay to lend money to the ECB for the duration of one night. At the moment, the deposit rate is negative: if banks deposit money with the ECB, they are actually punished for it.
‘The idea behind that policy has always been that banks would rather lend their surplus money to companies and households, and thus pass them on to the real economy. For example, the ECB fueled inflation for ten years because it was too low at the time.
“Now we are in the opposite scenario, where inflation is much higher than the ECB’s target of 2 percent. By raising interest rates in the near future, the ECB wants to make it more expensive for businesses and citizens to borrow, which should cool the economy.’
Will it then be lucrative for banks to deposit their money at the ECB after next month?
‘No, even after next month’s increase, the deposit rate will remain negative, at minus 0.25 percent. So the ECB still encourages banks to lend money to citizens and businesses – the opposite of what you actually want to achieve. Only after the increase in September will we find ourselves in a situation where banks are no longer penalized for storing their money at the ECB. The level at which interest rates no longer stimulate the economy – neutral interest in jargon – is even higher.’
Does a citizen notice anything of this interest rate increase on his savings account?
‘No, not right away. It is only after September that it is possible that the Dutch will again receive some return on their savings account. But don’t forget that it will still be far too little to compensate for the loss of purchasing power caused by inflation.’
Should the ECB have raised interest rates sooner?
The ECB is lagging behind what other central banks are doing. This is due to what – again apologies for the jargon – forward guidance is referred to as ‘providing policy indications’. The ECB wants to conduct monetary policy that is as transparent and predictable as possible. In normal times this is understandable: the ECB does not want to scare the financial markets. But when inflation soared due to Russia’s unexpected invasion of Ukraine, the ECB should have turned around sooner.’
So why is the ECB going to raise interest rates now?
‘Within a central bank you always have a battle of directions between hawks and doves. The hawks say: fight inflation at all costs. The pigeons mainly believe that a central bank should create economic growth. When ECB President Christine Lagarde took office at the end of 2019, she said she was neither a hawk nor a dove herself. In her own words, she was a wise owl: she wanted to reconcile everyone.
‘For years inflation was far too low and the pigeons were in charge within the ECB. Now that we are in the position that inflation is structurally high, you can see the hawks stirring. In that sense, it is not surprising that the ECB is now going to raise interest rates.’
When will we know if this policy has worked?
‘That will have to become clear in due course, but these kinds of decisions are always immediately reflected in the market. On Thursday, interest rates on southern European government bonds rose due to unrest that countries such as Italy will soon no longer be able to bear the higher interest rates on their debt mountains.’
Finally, a major financial Twitter account pointed to your performance at Thursday’s press conference. One of your questions became called a ‘classic European low-key sneer’† What question did you ask?
“The ECB has been forecasting for ten years that the policy it pursued would bring inflation to around 2 percent within a few years. Nevertheless, inflation remained below that level for years, despite all the measures taken by the ECB. My naughty question to Lagarde was therefore: why do you now have confidence that it will work? Past experience does not give the impression that the ECB has great credibility in achieving its inflation target. She gave a long and elaborate answer, but it wasn’t very clear†
‘I asked Klaas Knot, the president of De Nederlandsche Bank, the same question last year, and it was a lot more explicit† He thought that the ECB was in line with some modesty in this regard. In the inflation process, he said, there’s a lot more we don’t understand than we do understand. Perhaps this is simply not an option for Lagarde to say. Financial markets want to be reassured that the central bank knows what it is doing. Sowing doubt yourself does not help with that image.