In its fight against inflation in the euro zone, the European Central Bank (ECB) has raised the key interest rate by 0.5 percentage points to 2.5 percent. This is the highest level since 2008. The central bank announced on Thursday that interest rates would have to rise significantly further because inflation was too high. The Governing Council’s decision to slow the rate hikes was expected. Most recently, the monetary watchdogs had added 0.75 percentage points twice in a row.
The ECB fears that an excessively sharp rise in interest rates, as has been the case up to now, could hamper economic development. Many economists are expecting a slight recession in Europe next year. In addition, central bankers assume that inflation has peaked. In Germany and the euro zone, the rate of inflation was ten percent in November and was thus – albeit very slightly – below the historical highs. Germany is experiencing the strongest inflation since the 1950s.
The social consequences of rising prices are serious. In view of the massive increase in the cost of living, households with low incomes can afford less and less. At the same time, the now higher interest rates on savings accounts are nowhere near enough to offset the high inflation. According to data from the Federal Statistical Office, employees in Germany have recently had to digest the longest-lasting fall in real wages since 2008.
The loss of purchasing power is likely to continue for quite some time. The Bundesbank expects inflation of seven percent for Germany next year, and the ECB expects 5.5 percent in the euro zone. This value is almost three times higher than the central bank’s self-imposed target. The currency watchdogs define price stability at inflation of two percent.
Experience has shown that it takes nine to twelve months before the central bank’s higher key interest rates slow down consumption and investment in all sectors of the economy. With their courageous turnaround in interest rates, the central bankers also want to prevent record inflation from getting stuck in people’s minds. The more consumers doubt that inflation will return to normal levels in the medium term, the more entrenched price increases could become. The consequences would be dramatic: Based on their inflation expectations, companies demand higher prices for their products – and employees higher wages. There would be an inflationary spiral.
Other central banks have also reduced the pace of their rate hikes. The Bank of England, the Swiss National Bank and the American Federal Reserve also increased the key interest rate “only” by 0.5 percentage points on Wednesday and Thursday. The fight against inflation is not over yet, said Fed Chair Jerome Powell: “We will stay on course until the job is done.”