As inflation soars, Eurozone will get first interest rate hike in 11 years

The European Central Bank (ECB) has reaffirmed that it will boost interest rates in order to bring down the eurozone’s surging prices.

The increase will be 0.25 percentage points, as most analysts had predicted, and will take effect in July, according to ECB President Christine Lagarde.

In September, another raise is expected, which might be higher than 0.25 percent if inflation “persists or worsens.”

The statement marks the first rate hike since 2011 and brings an end to a long period of accommodative monetary policy.

After a meeting of the Governing Council in the Netherlands, Lagarde remarked, “High inflation is a big concern for all of us.”

“We believe that, based on our current assessment, a gradual but sustained path of further interest rate hikes will be appropriate.”

Lagarde had been referring to increasing inflation as “temporary” for months. However, after Russia invaded Ukraine, economic expectations were turned upside down, and the trend became even worse.

Inflation in the eurozone reached a new high of 8.1 percent in May, pushed up by the conflict, a protracted power shortage, and new supply chain disruptions. This was four times the central bank’s desired yearly objective of 2 percent.

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Consumers and businesses are increasingly dealing with volatile prices, placing pressure on policymakers to provide meaningful solutions, even if there is nothing they can do in the short term to help.

Inflation is wreaking havoc on other rich economies, with banks signalling their determination to raise interest rates before stagflation sets in.

For the next few years, the ECB anticipates inflation to stay “unacceptably” high: 6.8% in 2022, 3.5 percent in 2023, and 2.1 percent in 2024.

“Russia’s unlawful action against Ukraine is having a significant impact on the euro area economy, and the prognosis remains bleak,” Lagarde warned. “However, the conditions for the economy to continue to develop and recover in the medium run are in place.”

The easing of coronavirus limitations, a healthy labour market, fiscal assistance, and citizen savings gathered throughout the epidemic, according to Lagarde, are all factors that can keep the economy going forward, albeit at a slower pace than previously forecast.

This is the first hike since 2011

The ECB’s action will have an immediate impact on the deposit facility rate, which determines how much interest other banks earn for depositing money with the ECB overnight.

At the height of the sovereign debt crisis in July 2012, the rate was slashed to 0.00, and it was then cut four more times, finally falling to -0.50 in September 2019.

The rate will rise to -0.25 in July and exit negative territory in September, as announced on Thursday, “normalising our monetary policy,” as Lagarde phrased it.

The primary refinancing operations’ rates and the marginal lending facility’s rates will both rise by the same amount.

In another sign of the times, Lagarde announced the end of the asset purchase programme (APP), an unconventional measure used to maintain price stability during the debt crisis.

The ECB purchases government and corporate bonds, as well as other asset-backed securities, totaling between €15 billion and €80 billion every month, as part of the programme.

The ECB wants to make borrowing more expensive for households and businesses by eliminating the APP and raising rates in July, in order to curb demand and induce a gradual price drop.

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“If demand weakens in the medium term, pricing pressures will be reduced,” Lagarde added.

A rise in interest rates also ensures that those who lend money now will not lose money when it is repaid later.

However, indebted nations such as Italy, Greece, and Spain, who have relied on the ECB’s zero rate policy to obtain liquidity and fund their obligations for years, may be affected by the plan.

Markets and investors had been speculating for weeks about how far Lagarde would be willing to go before she made her pronouncement on Thursday. In the end, she chose a gradual 0.25 increase over a 0.50 increase, as several member states had recommended.

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