Continued high inflation in Europe and the United States has led to unprecedented intervention by central banks in both areas. The US Federal Reserve raised its key interest rate by 0.75 percentage point to between 1.5 percent and 1.75 percent on Wednesday evening. Earlier in the day, the European Central Bank announced that it was preparing to buy up government bonds from weak euro countries in a targeted manner. With this, the central bank wants to lower the interest rates on the government bonds of these countries.
For days, financial markets have been captivated by the monetary authorities’ response to inflation. This has risen sharply under the influence of the corona pandemic and the war in Ukraine and will remain high for longer than expected. In both Europe and the US inflation is over 8 percent.
Central banks have entered a complex playing field. On the one hand, inflation must be curbed, on the other hand, debt-laden countries such as Italy must be prevented in Europe from getting into trouble due to rising interest rates.
The Federal Reserve, also known as the Fed, had it relatively easy. The US central bank system has been raising interest rates for months, and is now throwing a few steps on top of that in one fell swoop. Further hikes are in line with expectations, said Fed chief Jerome Powell, who is projecting interest rates of 3.5 to 4 percent by the end of this year.
Let’s surprise
The fact that the Fed now had to take such a huge step – usually interest rates rise in steps of 0.25 percentage point – also shows that the central bank has been surprised. The combined effect on inflation from the war in Ukraine (which is driving up energy and food prices), new lockdowns in China (which frustrates the supply of products) and the effects of the huge bailout package from the Biden administration turned out to be much greater than expected.
Also read: A tumultuous day for inflation tamers
At the ECB, the struggle is a lot more complicated. Inflation also does not want to fall in Europe, and after a long delay, the ECB decided just last week to gradually raise key interest rates in Europe in the coming months. The period of negative interest rates will finally come to an end. Ideally, the ECB would also have immediately announced that sovereign debt from high-yield countries (Italy, Greece, Spain) would be supported, but that would have detracted from the overall eurozone rate hike as a much-needed brake on inflation. After all: a higher interest rate makes borrowing expensive and puts a brake on consumption, while buying up government bonds actually depresses interest rates (in the longer term). Pushing and pulling at the same time doesn’t work.
The ECB’s involvement in keeping the euro afloat ‘knows no limits’, said director Isabel Schnabel
Echo of atmosphere of the euro crisis
After the interest rate decision, government bond yields for euro countries rose sharply in recent days. More worryingly, within the eurozone, the difference between a German and an Italian government bond had risen to 2.52 percentage points. That so-called spread is seen as an indicator of how difficult it will be for Italy to finance its own debt on the capital market. Countries that also had their economies insufficiently in order before corona are now in danger of getting into payment problems due to the higher interest rates. This could ultimately jeopardize the sustainability of the euro.
Strong intervention was therefore inevitable, ECB executive Isabel Schnabel already announced on Tuesday evening. The ECB’s involvement in keeping the euro afloat “knows no bounds,” she said. After the ECB’s announcement on Wednesday that it would buy up government debt in a targeted manner, the difference between German and Italian loans immediately fell to 2.23 percent.
The ECB’s decision thus echoes the atmosphere of the euro crisis ten years ago. Then ECB President Mario Draghi said that the central bank “whatever it takes” would do to save the euro. The big difference now is that the ECB is taking the space to raise interest rates for the ‘healthy’ countries, and seems to have found a way to continue to support the ‘weaker’ countries. It should become clear in the coming days whether this double signal can convince the capital markets as much as Draghi’s cannon shot of the time. In addition, it is a wry twist of fate that Draghi is now prime minister of Italy and is forcing his successor Lagarde to intervene again.
Inflation dampers p. E2-3