The European Central Bank announced a 75 basis point interest rate rise last Thursday, taking its benchmark deposit rate to 0.75%, making it the largest-ever interest rate hike. This action follows the U.S. Federal Reserve and other global banks’ attempts to reduce soaring inflation levels that are pushing Europe towards a recession.
With this change, the benchmark rate for the 19 euro-using nations will be 0.75%. It comes after the first increase by the central bank since 2011, when rates were raised to zero after years in negative territory. The ECB stated in a statement that it anticipates raising rates further forecasting an average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.
Following an increase from -0.5% to zero at its meeting in July, the ECB made the decision. Since 2014, the central bank has maintained rates in the negative range in an effort to boost consumer spending and combat low inflation.
However, inflation in the Eurozone reached 9.1% in August as a result of increased food and energy costs. Since the invasion in February, Europe has been attempting to wean itself off of Russia's exports of natural fuels. As a result, Moscow has reduced natural gas exports to Germany and other EU nations, driving up prices and requiring governments to subsidize consumer and company energy costs by hundreds of billions of dollars.
“There seems to be universal agreement that higher rates are required to prevent higher inflation becoming embedded, though [Russian] President Putin is creating a lot of slack in the European economy already,” said Kit Juckes, a strategist at Societe Generale.
The effects of decades-high inflation are already being felt. According to recent polls, business activity declined in August for the second consecutive month, with Germany's economy, the largest in Europe, experiencing a particularly sharp decrease. In the third quarter, Europe could see a decline in the region's gross domestic product, which is the broadest indicator of its economy. A recession in Europe is on the horizon, according to economists.
The drastic increase in inflation rates has been criticized by some experts as the ECB are carrying out this decision to minimize cost-push inflation, the rise of overall prices due to increases in the cost of wages and raw materials. Because of high inflation rates, businesses struggle to cover their costs, therefore required to take on a bank loan. Similarly, customers have less disposable income due to the rise in prices of essential goods and services, such as electricity and petrol, and thus there is an increasing trend in the demand for bank loans. By increasing interest rates, the ECB has made loans more expensive, adding to the rising costs of businesses and customers alike. This in turn, according to European officials, could deepen the European recession predicted for the end of this year and the beginning of 2023.
“The ECB and other central banks have been torn between the need to crush inflation and their realisation that recession risks continue to increase,” explained Willem Sels, global chief investment officer at HSBC.
“Gas prices have been rising sharply, and we know that the ECB is concerned that rising inflation leads to higher wage demands, which could make inflation pressures more sticky,” he added. “Monetary policy acts with a lag, and ECB governors may have judged that it is better to front-load rate hikes and to finish hiking by the end of the year.”
In hiking rates, the ECB has trailed behind other global central banks. The COVID-19 epidemic and its lingering repercussions, which have raised energy prices and constrained supplies of parts and raw materials, caught central banks worldwide off guard and forced them to act quickly.
Following years in which borrowing costs and inflation stayed low due to broad dynamics including globalisation, ageing populations, and digitization, an abrupt push to boost interest rates has been launched.
“It still seems likely that, once the ECB realises the depth of the recession that we expect to unfold, the ECB will put rate hikes on hold at some time in early 2023,” noted Holger Schmieding, chief economist at Berenberg.
Anna Alandete
14/9/2022
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