Status: 04/06/2022 10:23 a.m
According to economists, the European Central Bank could push energy prices in Germany by four percent with the help of interest rate hikes. The reason for this is the euro appreciation expected in this case.
According to a study, interest rate increases by the European Central Bank (ECB) can lower energy prices in Germany. According to a study by the German Institute for Economic Research (DIW), these are likely to fall by up to four percent.
The reason for this is the expected appreciation of the euro. Rising interest rates make the currency more attractive, leading to higher demand. The appreciation – ie the increase in value of the euro against a foreign currency – automatically reduces the prices for oil products traded in dollars.
According to the DIW, heating costs and fuels react strongly
“The present calculations have shown that a tighter monetary policy also has a significant effect on energy prices,” concludes the DIW researchers Alexander Kriwoluzky, Gökhan Ider and Frederik Kurcz. Although the ECB’s interest rate decision does not significantly affect energy prices on the world market, it does affect the value of the euro.
“If the euro appreciates, consumer prices for fuel and heating costs in Germany will drop significantly,” say the experts. According to the DIW model, a rate hike that increases the yield on one-year Bunds by 25 basis points would dampen German consumer prices by 0.2 percent in the same month. After all, that corresponds to a tenth of the annual inflation target of the ECB, which is two percent.
“Both heating costs and fuel react strongly to an increase in interest rates,” the study says. Fuel prices would fall by more than four percent in the month of the interest rate shock. “The prices for electricity and heating energy also fall by up to two percent and drop significantly for around ten months.”
Exchange rate could rise by two percent
The effect is due to an appreciation of the euro. “Since the interest rate hike has made investing in euros more attractive for investors, the euro is appreciating against other currencies,” say the economists. “After the interest rate hike, the effective exchange rate of the euro rose sharply by 2 percent and remained elevated for around ten months. This means that buyers from the euro area are getting 2 percent more of the oil traded in dollars for the same amount in euros.”
For households that pay for petrol at the petrol station in euros, this translates directly into lower prices. The price of oil itself is also falling as a result of the interest rate shock, but is only affected for a very short time. Gas, which is usually traded in euros, is also becoming cheaper, but for a shorter time and, above all, far less than heating oil. “The gas prices in the residential index fall by only one percent, while the prices for heating oil fall by nine percent.”
Unlike the US Federal Reserve or the Bank of England, the European monetary watchdogs have not yet initiated the turnaround in interest rates – although the inflation rate in Germany is currently 7.3 percent, the highest since 1981. It was not until the end of the year at the earliest that the ECB signaled a departure from its long-standing zero interest rate policy.
Unpleasant side effects
With an interest rate hike, the ECB theoretically has an effective tool at its disposal to stabilize prices in the euro area as a whole, the DIW researchers write. However, this also has an undesirable side effect: industrial production would be slowed down due to the relatively expensive goods for foreign countries, and unemployment would rise.
“Poorer financing conditions and falling demand mean that the unemployment rate rose by a little more than 0.1 percentage point after the shock,” it said. While industry is recovering quickly and returning to baseline levels after around three months, the increase in the unemployment rate is more sustainable.
“The ECB is in a difficult position due to the war in Ukraine, with sharply rising energy prices and an endangered economic recovery,” conclude the economists. “Through restrictive monetary policy, it can brace itself against rising consumer and energy prices, but in doing so risks slowing down the recovery in economic activity.”