Monetary policy: where is the ECB headed?

How far will interest rates rise in the fight against inflation? In any case, the monetary watchdogs of the ECB want to accept an interest rate level that will also affect the economy.

She had hesitated for a long time, but in the summer the European Central Bank took up the fight against rampant inflation in the euro zone. Since July, the monetary watchdogs have increased their key interest rate in three steps, starting from a negative level, by a total of 2.0 percentage points. The deposit rate that financial institutions receive from the central bank for parking excess funds is now 1.5 percent. There is no doubt that he must continue to rise.

More important than the question discussed on the financial markets as to whether the next rate hike on December 15 will be 0.75 percentage points for the third time in a row or “only” 0.5 points is the target level that the current cycle is headed for . Not only the economic prospects are significantly influenced by this; the key interest rate is also an important basis for the return on interest-bearing investments and thus for long-term capital formation.

While it is clear that this target level will be primarily determined by the further development of inflation, the first indications for the future interest rate are emerging. ECB President Christine Lagarde recently emphasized again that the Monetary Policy Council makes its decisions dependent on the data available and on decide session after session.

A neutral interest rate level is not the end

In view of the stubbornly high inflation, however, the determination of the euro monetary policymakers, who are regarded as rather cautious, to go beyond a significant pain threshold with their interest rate hikes is increasingly recognizable. This pain threshold bears the name “neutral interest rate level”, i.e. a level that no longer pushes the economy. Economists currently see this level being reached at a deposit rate of two percent. Above this, the zone of a “restrictive interest rate level” begins, which slows down economic activity.

In the fight against inflation, the ECB will probably venture into this area, Lagarde said at the European Banking Congress in Frankfurt in the middle of the month. “We assume that we will continue to raise interest rates – and withdrawing the stimulus may not be sufficient,” said the ECB chief. Bundesbank President Joachim Nagel added that it would be wrong to wait to take further decisive steps for fear of a downturn.

recession is accepted

Monetary policymakers are now less discussing whether a recession can be avoided and more about how much a moderate downturn can help to get inflation out of control. As indicated in the minutes of the last Governing Council meeting in late October, the Governing Council tends to continue tightening in the event of a moderate recession, while pausing in the event of a prolonged and deep recession that would likely dampen inflation more .

The same meeting also pointed out that the impact of producer prices on consumer prices is still providing further upward pressure. Agnès Belaisch, chief strategist for Europe at Barings Investment Institute, estimates that while price pressures from energy markets have been easing for some time, the upheaval in consumer prices could continue into the spring.

Monetary politicians are concerned above all with the after-effects of the spring and summer price shock. In any case, the monetary watchdogs have no direct influence on energy prices – but they do have an important longer-term factor, namely inflation expectations. These determine the price decisions of consumers and providers and have a major influence on the so-called second-round effects of inflation.

Still a long way

If the expectations of economic subjects – i.e. the actors participating in economic life – get out of hand, there is a risk of accelerated devaluation and a loss of confidence in one’s own currency. In monetary policy jargon, therefore, a key objective of monetary watchdogs is to “anchor” long-term inflation expectations. The “medium-term” ECB target of an inflation rate of two percent seems even further away.

This can only be achieved with further resolute measures, flanked by the already decided phasing out of the lavish bond purchases from next year. Where the interest rate hikes will ultimately lead is highly controversial among experts. According to the ECB’s last survey of monetary policy analysts (“Survey of Monetary Analysts”) in October, those surveyed assumed that key interest rates would be between 2.25 and 3.00 percent in the coming year. Given the major challenges, that might be too cautious an expectation.