“The European Central Bank must raise the interest rate by at least half a point in December to deal with the peak inflation” says the member of the Central Bank (ECB) and chairman of the board of the Central Bank of Lithuania, Gediminas Simkos, who thinks that an even faster increase is now required on the continent And for him, a faster increase is still a real possibility.
The next meeting of the ECB will take place on December 14-15, when in the meantime inflation in the European Union has already reached an annual rate of 10.7%, the highest level ever. According to Simkos, it is clear that the price increase is still too fast, so the interest rate will have to continue to rise in 2023 as well, but it is too early to say by how much. He added that the decision to reduce the ECB’s bond portfolio will also play a role in the upcoming meeting.
How much will the bank raise the interest rate? According to Simkos, “it is clear that 50 basis points is a must. Because we still see very strong inflationary pressures and we need to reduce them as soon as possible to avoid de-anchoring inflation expectations. An increase of 75 basis points is also possible.” Although he qualified a bit, noting that without seeing the updated inflation and economic growth forecasts, which will provide a first glimpse into 2025, “it’s a little early to judge.”
Simkos, like others at the ECB, says that an economic contraction (ie a recession) will not significantly change the course of the ECB. “I don’t think it’s going to be deep and I’m sure the recession by itself won’t solve the inflation issue,” he said.
And what about reducing the bond balance?
“We will also have to agree on the key parameters to shrink the bonds accumulated as part of the market stimulus programs in previous years – a process known as quantitative tightening. This can affect the discussion on credit costs,” Simkos said, adding “You need a holistic point of view, not judging one tool without thinking What are you going to do with the other one. I don’t see them as substitutes, but of course they have some compensating effects, meaning there’s a synergy between them. If you go more moderate with one, you can make stronger moves with the other.”
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He advocates a cautious, if relatively early, start to reducing the ECB’s bond balance sheet. “The sooner we start quantitative tightening, the better. But in smaller steps, so that it can run somewhere in the background.”
He also cast doubt on the expectations of economists in a Bloomberg survey this month that the ECB would end up raising interest rates in March. “They will continue to increase next year, moving into restrictive territory,” according to Simkos. “We do not act according to the number of meetings in which we need to achieve some final interest rate. What we need is the result, which is 2% inflation in the medium term. And if necessary, we will continue this even after March. That is completely clear to me.”
What do other European economists think?
The European Union is very afraid of the approaching recession, and there are those who say that Europe is actually already in a recession. The president of the Bundesbank (Germany’s bank), Joachim Nagel, warned this week that it is too early to determine the amount of the next interest rate increase, although he said it would certainly be a “strong” move. On the other hand, the Portuguese Mario Centeno said that he sees conditions that already make it possible to slow down the pace.
The one who hinted last week about a direction similar to that of Simkos is Luis de Guindos, the vice president of the bank, who said: “We will do everything necessary to reduce inflation to a level we consider to be price stability, which is 2%.” He added that the main risk to the “spiral” in wage prices is the perception that the credibility of the central bank is not strong enough. “That is why we commit to price stability… and that we will do everything necessary to reduce inflation to a level we consider to be price stability, which is 2%,” he said. Wages in the Eurozone have risen but not yet at an “excessive” pace, he added. However, he emphasized that the lesson from the stagflation seen in the 1970s is that monetary policy should be focused on to avoid negative effects afterwards.
Meanwhile, the interest rate in Europe is already at 2%, after the bank’s previous interest rate hikes. True, it is far behind the USA (3.75% to 4%) and Israel (3.25%) but the European Bank has additional problems – while the monetary policy (money management) is uniform in the Union and determined by the central bank, each country manages a fiscal policy (government ) is different from hers.
Beyond that, there is a big difference between the strength of the countries in the Union – it is impossible to compare the strength of Germany and France to that of Spain and Portugal, and certainly not to that of Poland and of course Greece, which lags far behind and enters the danger of bankruptcy every few years, which necessitates a bailout. The levels of unemployment in the EU countries also differ significantly, where in some countries unemployment is very high and in some it is more reasonable. All these make it difficult to make a uniform monetary decision throughout the continent. Union has power but it also has disadvantages, and when interest rates are raised they float again.
In any case, after the next interest rate hikes, the interest rate in Europe will already approach the level of a ‘neutral interest rate’ – one that is considered not to encourage economic activity but is not too restraining, and this comes when the Fed, the central bank of the USA, may also be expected to start slowing down the increases His interest rate, following the beginning of the moderation of inflation in the US to 7.7% in October (which boosted Wall Street by 7% and another 2% two days in a row.