Not one, not two, but three or more rate hikes this year. That is the perspective that the European Central Bank outlined on Thursday after a board meeting in Amsterdam. The central bank is launching a broad attack on the peak inflation in the eurozone (8.1 percent in May). It is a catching-up maneuver after recent months, when the ECB has adopted a rather wait-and-see attitude. The ECB ‘intends’ to raise interest rates for the first time in July. This should be done again in September. And after that, the ECB foresees even more interest rate hikes.
Amsterdam thus became the scene of an important moment for the central bank. The ECB last raised interest rates in 2011. The bank holds a policy meeting once a year outside Frankfurt, where the central bank is based. This week the meeting was held in Amsterdam in the chic hotel The Grand, dinner was held in the Hall of Fame of the Rijksmuseum in the presence of the royal couple, the press conference took place in the Hermitage museum.
If the ECB sticks to the interest rate path outlined now, the deposit rate for banks at the ECB will go from minus 0.5 percent to minus 0.25 percent in July. The other interest rates for banks are also rising. In September, the ECB foresees an interest rate hike of another quarter of a percentage point or higher, if inflation expectations “continue or deteriorate”. The option of an extra high rate hike in September was not foreseen by most analysts. After September, the ECB board expects to implement ‘further interest rate hikes’.
Savings accounts may start to yield some interest again after this ECB decision
Rising ECB interest rates mean that there is a growing chance that banks will start to give some interest on savings accounts again. Mortgage interest rates, which fluctuate with interest rates on the capital markets, have been rising since the turn of the year. This is partly because the ECB has started buying less government and corporate bonds. With these purchases, it depresses interest rates on the capital markets. New bond purchases will stop this month, the ECB announced on Thursday, although the already bought bonds will remain on the ECB’s balance sheet for the time being.
changed world
Raising interest rates is the standard way for central banks to curb inflation. At a higher interest rate, borrowing becomes more expensive, which slows down consumption and subsequently price increases. It also makes saving more attractive – causing consumption to fall further. ECB President Christine Lagarde called inflation “undesirably high” and “widespread” during the press conference. It’s not just energy prices (scarcely 40 percent higher than last year) that fuel inflation, she said.
The ECB aims for inflation of 2 percent within a period of about two years. That 2 percent serves as a buffer against ‘deflation’: a downward price spiral that can ruin the economy. In recent years, the ECB has pulled out all the stops to boost the low inflation rate to 2 percent, with negative interest rates and massive loan purchases.
The world has now changed. Supply chain disruptions during the pandemic caused shortages of all kinds of products, pushing prices up. The rapid economic recovery, fueled by governments with multi-billion dollar aid, meant increased consumer spending, further pushing prices up. And then came the war in Ukraine, which mainly pushed up energy and food prices.
The ECB board “will ensure that inflation returns to 2 percent in the medium term,” said a determined Lagarde. The question is whether the ECB will succeed in this. According to critics, such as Lex Hoogduin, former employee of former ECB president Wim Duisenberg, the ECB reacts much too slowly to inflation. One of the risks is the increase in collectively negotiated wages in the eurozone, often in response to the rise in prices. Wage increases can fuel further inflation as they put employers at risk. They often pass these costs on to the consumer. According to Lagarde, there is still no question of a dangerous ‘wage-price spiral’.
Also read: The ECB spins in the whirlwind of inflation
Thursday’s decision was taken unanimously. Even ‘hawks’ who have been in favor of higher interest rates for some time, including Klaas Knot, the chief of De Nederlandsche Bank, agreed with it. The unanimity is a boost for Lagarde, who attaches great importance to good relations within the board. She was visibly pleased. Amsterdam had contributed to the good atmosphere, she suggested. “Geography Matters.”
recession risk
Nevertheless, the ECB faces a difficult period. The attack on inflation will be a venture. There is a risk that the eurozone will enter a recession, especially if Russia stops energy supplies. The war in Ukraine is already hitting the economy “hard,” Lagarde said. A series of rate hikes could aggravate such a recession. Then the ECB will have to choose between fighting inflation and fighting recession.
The end of the buyback of government bonds also means that borrowing costs for governments could rise further. They went into extra debt during the pandemic. Vulnerable Southern European economies in particular could get into trouble. The ECB says it wants to avoid this: ‘fragmentation’ must be prevented. The ECB mentions Greece, but Italy also poses a problem. If necessary, the ECB can continue to buy Greek and Italian debt, while the purchase of debt from other euro countries is stopped.