This is a historic decision, a first for 11 years. The main interest rate goes from -0.50% to zero.
The European Central Bank (ECB) decided on Thursday to increase its interest rates for the first time in more than ten years in the face of galloping inflation, choosing to strike hard with a higher rise than expected despite the political crisis that has opened up in Italy.
Caught in a complex trade-off between rising prices and fears for growth, the Frankfurt institution chose boldness: it raised its three key rates by 50 basis points after having prepared people’s minds for an increase of only 25 points. Speculation had increased in recent days on more aggressive action by the ECB as inflation in the eurozone continues to climb under the combined effect of the post-Covid recovery, tensions in supply chains and of the energy crisis linked to the Russian offensive in Ukraine.
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“The interest rates on the main refinancing operations, the marginal lending facility and the deposit facility will be raised to 0.50%, 0.75% and 0.00% respectively from 27 July 2022“, is it detailed in the press release of the ECB. This decision marks the end of the era of negative interest rates that began in 2014 and the end of a decade of generous monetary policy that helped the economy overcome the crises of recent years.
complex task
This tightening of monetary policy had already begun in July with the halt to new debt purchases on the markets. Objective: to reduce the money supply in circulation and curb inflation which broke a new record in the euro zone last month, at 8.6% over one year. The Frankfurt institution therefore ends up joining the ranks of other central banks, such as the American Fed, which have been much more active for months against soaring prices. The ECB’s task is nevertheless even more complex due to the growing threats of cuts in Russian gas supplies, the risk posed by the political crisis in Italy and the fall of the euro.
Prime Minister Mario Draghi tendered his resignation to the Italian president on Thursday. With his pedigree as a former president of the ECB, he was seen as a factor of stability by the markets. The departure of Mario Draghi could lead to a dissolution of Parliament and early elections this fall. His resignation immediately caused the Italian borrowing rate to take off again on the market.
To ward off the specter of a new sovereign debt crisis, the European Central Bank also announced on Thursday a new instrument to protect the most fragile states against speculative attacks. The latter was designed to smooth out the gaps between borrowing rates, or “spreadsbetween risk-free borrowing countries, such as Germany, and other more fragile ones, such as Italy. The ECB argues that these “spreadshamper the proper transmission of its monetary policy. But strict conditions of use must be defined, the guardians of the euro not having the right to help governments budget.
This tool “can be activated to counter unwarranted and disorderly market dynamics that seriously threaten the transmission of monetary policy in the euro areawhich aims for an inflation rate of 2% in the medium term, according to a press release after the Board of Governors.
The pioneering United States
The US Federal Reserve has raised interest rates since March and its range for the federal funds rate, now between 1.5 and 1.75%, could be raised by 75 basis points at the end of July. In the euro zone, the gas crisis complicates the task of the ECB.
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The Nord Stream gas pipeline linking Russia to Germany certainly restarted Thursday after ten days of maintenance, but at a reduced flow compared to that preceding the work and which itself represented 40% of capacity since mid-June. A complete stoppage of gas deliveries by Moscow would plunge the euro zone into recession and a too rapid rise in rates would aggravate the situation.
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