The European Central Bank is expected to raise interest rates, which are currently negative, to zero until September and may continue to raise interest rates after that, President Christine Lagard said, noting that the bank’s experiment with negative interest rates over eight years is coming to an end.
The change in policy, described in a blog post by the European Central Bank on Monday, was announced after decisive actions by the US Federal Reserve and other central banks to end the easy money policy as inflation rises around the world. , Which until recently preferred a different approach from the Federal Reserve and supported a very gradual rate hike.
European Central Bank policymakers expected inflation to fall sharply to their target of 2% this year. Instead, it rose further, reaching 7.4% in April, the fastest rate of appreciation since the euro was formed in 1999. Policymakers also feared raising interest rates aggressively due to concerns about the shock to economic growth following the war in Ukraine, which threatens to cause a recession across the bloc.
Despite these considerations, Lagard wrote that the European Central Bank may raise interest rates in July for the first time in 11 years. “Based on current forecasts, we will probably be in a position to stop negative interest rates by the end of the third quarter,” Lagard wrote in a post posted on the bank’s website. The interest rate of the European Central Bank is currently minus 0.5%.
“Once inflation forecasts have changed significantly upwards from the period before the epidemic, it is appropriate to adjust the nominal variables – and that includes interest rates,” Lagard wrote.
The guard changes direction
The euro rose nearly a cent against the dollar after the blog was published, trading at $ 1,068. Yields on the Italian government’s government debt for a decade have also soared. Yields rise as prices fall.
This is the first time that Lagard has announced such a aggressive change of direction in interest rates. It has previously said that the European Central Bank may start raising interest rates in July and that any increase after that will be gradual.
After September, it suggested to Guard that the bank continue to raise interest rates in the direction of the so-called neutral interest rate, which supports an economy that will be at its peak of output but maintains constant inflation. Some senior central bank officials have estimated that the EU’s neutral rate should be between 1% and 1.5%.
From these things it can be predicted that the European Central Bank may raise interest rates by a quarter of a percent in each of the seven policy meetings to be held between July and April next year, reaching a level of 1.25%, said Michael Schubert, an economist at Commerzbank.
François Villaroy de Galho, who sits on the committee that sets the interest rate as the central bank commissioner of France, said on Monday that an agreement to raise interest rates at the European Central Bank “is probably a fait accompli” and pointed to a broad rise in eurozone prices.
“We are still in the process of releasing the catalyst,” Wilroy de Galho said of the European Central Bank’s policy, at a panel of the World Economic Forum in Davos, Switzerland. “It remains to be seen if after (we get to) a neutral (interest) rate we will have to press the brakes.”
A series of interest rate hikes poses risks to the eurozone economy, which has not fully recovered from the shocks of the corona. The war in Ukraine is hurting household incomes because it has caused food and energy prices to rise and it is hurting the security of various businesses.
But pressure on the European Central Bank is mounting, including on the part of Germany, the largest economy in the bloc, whose inflation recently peaked at four decades on an annual basis, 7.4%. German Finance Minister Christian Lindner warned on Friday that a weak euro could cause inflation in Europe to rise, and encouraged the European Central Bank to raise interest rates, an unusual move for a country that often greatly sanctifies the independence of the Central Bank.
The Fed has already started raising interest rates
Across the ocean, the Federal Reserve is raising interest rates as part of its most aggressive effort in decades to fight upward price pressures. Federal Reserve officials approved a half-percent increase earlier this month, the highest since 2000, as well as a plan to shrink the US Federal Reserve’s $ 9 trillion assets portfolio. This will raise the interest rate in the Federal Reserve’s benchmark funds to the target range of 0.75% to 1%.
Fed Chairman Jerome Powell said the bank generally agreed that interest rates would probably need to be raised by another half a percent in June and July given current economic conditions.
Legard said the European Central Bank is willing to act more aggressively if necessary. “If higher inflation appears to threaten to cut inflation expectations, or we notice signs of a more permanent loss of economic potential limiting resource availability … we will need to stop the easy money policy quickly to eradicate the risk of a self-fulfilling prophecy,” she wrote.
The last time the European Central Bank raised interest rates, in 2011, was up a quarter of a percent. Some bank officials have recently suggested that the bank take greater steps, perhaps raising interest rates by half a percent at its July 21 policy meeting.
Inflation due to unwillingness to raise interest rates
The rise in inflation in the eurozone partly reflects the Russian invasion of Ukraine, which disrupted energy supplies to Europe and increased the energy burden on the region as a percentage of GDP above the levels recorded in the early 1970s, according to BlackRock calculations.
Peak inflation also partially reflects the weakness of the euro, whose value against the dollar was hurt by the European Central Bank’s unwillingness to raise interest rates. The euro has fallen to almost parity against the dollar in recent weeks, and by the time the blog was published with Laguard’s remarks on Monday, it was trading at about $ 1.05, compared to about $ 1.22 a year ago.
The weak euro has both advantages and disadvantages for Europe. It makes the export of European products and goods cheaper to international markets and thus supports large exporters from Germany and other countries. But it also micro imports goods into the eurozone and thus raises inflation. If the value of the euro falls against other currencies, it takes more euros to buy goods whose prices are denominated in these currencies. This is especially true because inflation is driven primarily by the prices of energy and commodities, whose prices are often denominated in U.S. dollars.
In her blog, she warned Guard that much of the inflation in the eurozone is imported out of the region.
“It acts as a ‘tax’ of terms of trade and reduces the total revenue of the economy – even if we take into account the higher prices earned by exporters,” she wrote. The eurozone transferred 170 billion euros, about $ 181.14 billion, or 1.3% of GDP, to the rest of the world between the second quarter of 2021 and the first quarter of the year, she wrote.
The European Central Bank is one of the few central banks that has lowered interest rates below zero in recent years to give their economy further encouragement. There are economists and officials at the European Central Bank who have long warned that this unusual tool could create distortions in the financial markets and the economy.