The European Central Bank (ECB) decided on Thursday to raise interest rates for the first time in more than a decade, surprising with a bigger-than-expected hike to fight inflation and despite Italy’s political crisis.
Caught in a complex trade-off between rising prices and fears of recession, the Frankfurt institution chose boldness: it raised its three key rates by 50 basis points after preparing people’s minds for an increase of only 25 points. The main interest rate thus goes from zero, the level where it has been camped since 2016, to 0.5%, while that taxing part of the bank liquidities not distributed in credit goes up from –0.5% to 0.
The decision on this turn of the screw was “unanimous” in the face of inflation which “will remain at an undesirable high level for some time”, according to the president of the institution, Christine Lagarde. The rise in prices in the euro zone – 8.6% in June – continues to increase under the combined effect of the post-COVID recovery, tensions in supply chains and the energy crisis linked to the Russian offensive in Ukraine.
The ECB thus closes the era of negative rates that began in 2014 and closes a decade of generous monetary policy that has stimulated the economy during the crises of recent years. After this strong impetus, the ECB will “continue the normalization of rates”, and this, “meeting by meeting”, assured Mr.me The guard. The next monetary meeting is scheduled for September, with new economic forecasts at stake.
“Eurozone inflation over the rest of the year will remain high and the pressure on the ECB to act will also be high in the short term,” said Konstantin Veit, portfolio manager at Pimco. This “historic” decision reflects the fear of the guardians of the euro to see the window of opportunity for an interest rate hike close, analyzes Carsten Brzeski, of ING bank.
complex task
This tightening of monetary policy in the euro zone had already begun in July with the end of new debt purchases on the markets.
The other central banks have been much more active for months against soaring prices, such as the Fed in the United States which took off its rates in March. But the ECB’s task is more complex due to the growing threats of a cut in Russian gas supplies, the risk posed by the political crisis in Italy and the fall of the euro. “The economic horizon is darkening”, and this, “for the second half of 2022 and beyond”, summarized Mme The guard.
In Italy – one of the most vulnerable economies in the monetary zone – the Prime Minister and predecessor of Mme Lagarde at the head of the ECB, Mario Draghi, submitted his resignation on Thursday. Early elections will be organized. His departure immediately boosted the Italian borrowing rate on the market. The spread with the German rate has reached its highest level since mid-June 2022.
Sovereign debt
To ward off the specter of a new sovereign debt crisis, the ECB also announced on Thursday a new instrument to protect the most fragile states against speculative attacks which increase their borrowing costs. The ECB considers that these “ spreads — difference with the rate of the German risk-free loan — hamper the adequate transmission of its monetary policy. Strict conditions for the use of this tool, known as the “transmission protection instrument” (IPT), have been defined, as the guardians of the euro can be accused of carrying out disguised state funding.
Mme Lagarde dodged repeated questions about whether Italy could be the first country to benefit from the ECB’s umbrella. The institute “does not take a position on internal political issues”, assured the former boss of the IMF. But, if necessary, the ECB “will not hesitate” to use the IPT, because it is “capable of doing things on a large scale”, she insisted.