Europe faces a turnaround in interest rates – Economy

Sometimes a look from afar changes one’s perspective, and so it was perhaps no coincidence that leading representatives of the European Central Bank (ECB) used a business trip to Washington to announce far-reaching changes in monetary policy on their home continent. In view of the massive rise in inflation rates, according to the message on the fringes of the spring meeting of the International Monetary Fund (IMF) and World Bank, Europe is facing an interest rate turnaround that could be much quicker and more decisive than indicated at the last ECB Council meeting just a week ago. As early as July, the key interest rate could therefore rise again for the first time since mid-2011, meaning that the era of zero interest rates in Europe would come to an end after six years.

The Council members who indicated such a course correction included Bundesbank chief Joachim Nagel, ECB Vice President Luis de Guindos and the central bank governors of Belgium and Latvia, Pierre Wunsch and Martins Kazaks. Nagel referred to the latest rate of inflation in the euro zone, which at 7.5 percent is almost four times as high as desired by the central bank: “The numbers speak their own language. In this respect, monetary policy is required.” In view of the war in Ukraine and further disrupted supply chains as a result of the corona pandemic, Germany also has to adjust to an annual average inflation rate “close to six percent”. Against this background, the first interest rate hike can be expected from the third quarter, i.e. from the beginning of July.

Central banks traditionally use their guidelines to influence construction, car financing and other lending rates in the economy. Low key interest rates tend to have a stimulating effect, while higher rates are intended to slow down the economic upswing and curb the dramatic surges in inflation that the world is currently experiencing. However, the monetary watchdogs can do little or nothing against rising energy prices and supply bottlenecks that can be traced back to wars, political conflicts or pandemic-related production losses. That was also the reason why ECB President Christine Lagarde had so far rejected rate hikes. From their point of view, the economic situation in Europe is too fragile and the central bank’s tools are too inappropriate to act quickly and possibly imprudently.

However, the most recent statements by their Council colleagues show that more and more leading ECB representatives are only partially following their President’s route. They share the concern that given the European Central Bank’s widespread inactivity, citizens and companies could lose confidence in the stability orientation of the currency watchdogs, adjust their inflation expectations upwards and further fuel the inflation trend through purchases brought forward and price increases. The fear of inflation could thus become a self-fulfilling prophecy that would make the ECB’s work even more difficult.

With every interest rate hike, there is a growing risk that the economy will stall

Nagel, de Guindos, Wunsch and Kazaks indicated that the central bank will end its purchases of government bonds and other fixed-income securities in June, which it has used for years to keep long-term interest rates low and support the economy. Then an initial increase in the base rate from currently zero and the deposit rate for banks from currently minus 0.5 percent is conceivable. “From today’s perspective, July, September or even later is possible,” said ECB Vice President de Guindos in an interview with the Bloomberg news agency. “We will look at the data and then decide.” The head of the Belgian central bank expressed a similar wish. Should there be more nasty inflation surprises in the next few weeks, as was the case at the beginning of April, a rate hike in July is “a scenario that I would definitely consider,” he explained.

Open detailed view

Wunsch’s Latvian counterpart, Kazaks, put it even more clearly. “An interest rate hike in July is possible,” he said, adding that he also believes that the financial markets’ assessment that the period of negative interest rates on the deposit rate will end this year is plausible. The ECB will normalize its policy step by step, “although step by step does not automatically mean slow”. Rather, it is about making “appropriate” decisions in the light of the most recent data.

However, with every increase in interest rates, there is also a growing risk that the already fragile economic upswing in Europe will be stalled or that the economy will even slip into recession. That would be the worst-case scenario for both euro-zone governments and the ECB, as it could result in a dangerous combination of high inflation and rising unemployment. Inflation warners like Nagel are therefore calling for a well-measured approach instead of “hurriedly turning the interest rate screw”https://www.sueddeutsche.de/wirtschaft/ sensible”.