European Central Bank joins global push for higher rates
FRANKFURT, Germany (AP) — The European Central Bank will join the U.S. Federal Reserve and other major central banks in raising interest rates on Thursday. The only question is how much — and whether the rush to make credit more expensive will push Europe and other major economies into recession at the cost of fighting record inflation.
ECB President Christine Lagarde said last month that the bank would raise rates for the first time in 11 years by a quarter of a percentage point at Thursday’s meeting and at least as much in September. That has led to talk of a half-point hike coming for the 19 countries using the euro, and analysts say a bigger hike could also come on Thursday.
The ECB is late to the party in its rate takeoff – a sign of inflation that has proven higher and more tenacious than expected and of the more fragile state of an economy heavily exposed to war in Ukraine and a reliance on Russian oil and natural gas. Recession forecasts have increased for the end of the year and into next year, with soaring electricity, fuel and gas bills dealing a blow to businesses and the purchasing power of individuals.
“The economic outlook is deteriorating day by day,” said Carsten Brzeski, chief eurozone economist at ING Bank. “At the same time, headline inflation continues to rise and, in our view, will only decline gradually towards the end of the year, if it declines at all. In hindsight, the very gradual and cautious normalization process that the ECB started at the end of last year was simply too slow and too late.
Recession fears helped push the euro to a 20-year low against the dollar, adding to the ECB’s inflation-fighting task by adding to already high energy prices. This is because the price of oil is in dollars.
Raising rates is seen as the standard remedy for excessive inflation, which currently stands at 8.6% in the euro area in June and largely driven by soaring energy prices. Bank credentials affect banks’ cost of borrowing – and thus help determine what they charge to lend.
But by making credit harder to get, rate hikes can slow economic growth, a major conundrum for the ECB as well as the Federal Reserve. The Fed raised rates an outrageous three-quarters of a point in June and could do so again at its next meeting. The Bank of England started the upward march in Decemberand even the Swiss central bank surprised with its first hike in almost 15 years last month.
The objective for all central banks is to bring inflation down to acceptable levels – for the ECB, it’s 2% per year – without tipping the economy into recession. It’s hard to fix as central banks reverse what has been a decade of very low rates and inflation. The ECB’s hike is the first since 2011.
However, the European economy is also worried about a possible cut in Russian natural gas which is used to generate electricity, heat homes and power energy-intensive industries such as steel, glass and agriculture. Even without a total shutdown, Russia has regularly reduced gas flowsleading European leaders to accuse the Kremlin of using gas to pressure country on sanctions and support for Ukraine.
These recession-related concerns lead analysts to believe that the trajectory of ECB rate hikes may have an upper limit after the hikes expected in September and through the end of the year.
The interest rate hike follows the end of the bank’s 1.7 trillion euro ($1.7 trillion) stimulus program that helped keep long-term borrowing costs low for government and businesses as they weathered the pandemic recession.
These borrowing rates in the bond market are rising again, especially for the most indebted countries in the eurozone like Italy. Resignation of Prime Minister Mario Draghi brought back bad memories of the European debt crisis ten years ago. There are fears that the former ECB president, who pushed policies intended to keep debt manageable and boost growth in Europe’s third-largest economy, is not there to help prevent the eurozone from sliding back into crisis.
Lagarde should unveil at least some aspects of a new financial safety net this would combat unwarranted public borrowing rates fueled by market speculation. However, this would likely not cover the higher borrowing costs resulting from imprudent government decisions.
The hassle is unique to the ECB because it oversees 19 countries that are in different financial situations but use a single currency.
The main ECB benchmarks are at historic lows: zero for loans to banks and minus 0.5% for demand deposits that commercial banks leave with the ECB. The negative rate is a penalty aimed at pushing banks to lend money instead.