For the first time, the European Central Bank has hinted at a possible rate hike before the end of this year to curb galloping inflation. During an online press conference Thursday from Frankfurt, Lagarde said that “inflation may well turn out higher than we expected”.
She spoke after an ECB board meeting that was dominated by the price hikes. The day before the meeting, European statistics agency Eurostat reported that inflation in the eurozone had risen from 5 to 5.1 percent in January – a higher percentage than most analysts had predicted. In the Netherlands, inflation in January was even 7.6 percent. There was “unanimous concern” in the 25-member ECB board about the “surprisingly high level” of price increases, Lagarde said.
In effect, she admitted that the central bank underestimated inflation. Until November, the ECB’s line of communication was that inflation was ‘transient’. After the December board meeting, the ECB’s tone was less firm. This Thursday, the tone was remarkably concerned.
In concrete terms, this means that the ECB may raise interest rates sooner than previously planned. Higher interest rates mean less money flows into the economy, which should dampen price increases. The ECB deposit rate for banks has been at an all-time low since the pandemic: minus 0.5 percent.
Interest rate hike this year?
In December, Lagarde ruled out a rate hike in 2022. First, the ECB would gradually phase out the purchase of government and corporate debt, thereby depressing capital market rates. The ECB has so far been slower than the US and UK central banks, which have planned several rate hikes this year and are phasing out their asset purchase programs. On Thursday, just before Lagarde spoke, the Bank of England raised interest rates from 0.25 to 0.5 percent. Four of the nine Bank of England board members even wanted to raise interest rates to 0.75 percent in one fell swoop. Incidentally, inflationary pressures in the US and the UK are generally higher than in the eurozone, although the differences are also large within the eurozone.
The next meeting, in March, will be decisive for the ECB. Then the ECB’s calculators will make new economic forecasts. In its December estimates, the ECB still assumed that inflation in the eurozone would be 3.2 percent for the whole of 2022, before falling to 1.8 percent in 2023 and 2024. a longer period. If inflation estimates turn out higher in March, the ECB will phase out the purchase of government and corporate debt faster than planned, Lagarde said. After that, the deposit rate can go up.
Citizens and investors
As she often does, Lagarde tried to get in touch with European citizens. They suffer from inflation, she said. She spoke of the “struggle” of people who “fill the tank, who have to put food on the table.”
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The scenario of faster rate hikes is also challenging for equity investors. Higher interest rates have a negative effect on share prices. A higher interest rate means a higher return on government bonds, making equities relatively less attractive as an investment. Also, future profits of companies are lower if the expected interest rate is higher. This affects the share price of those companies now. European stock exchanges, including the AEX, plunged during Lagarde’s press conference.
The exchange rate of the euro in US dollars rose by a full cent from 1.13 to 1.14 due to the ECB news. Higher interest rates in the eurozone mean a higher yield (the interest rate) on government bonds in the eurozone. The euro is therefore more in demand on the financial markets.