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The European Central Bank (ECB) raised two key interest rates three-quarters of a point last week, the second such raise in the ECB policy committee’s last two meetings.
The overnight deposit rate, which banks earn by storing their money at the ECB, will rise to 1.5 percent on 2 November, officials announced.
In contrast, the rate at the U.S. Federal Reserve is between 3 and 3.25 percent and 2.25 percent at the Bank of England.
Meanwhile, inflation across the Eurozone ran at a 40-year record rate of 10.7 percent in October, up from 9.9 percent in September, driven by fuel costs that have grown 41.9 percent in the past 12 months. Food added 13.1 percent to its costs.
Inflation was highest in France, Germany, and Italy, according to Eurostat, the Eurozone’s statistics agency.
“We are not done yet; there is more ground to cover” with higher rates, ECB president Christine Lagarde told a post-meeting press briefing.
Still, the region’s economy will remain weak through 2024 as “high inflation continues to dampen spending and production” by “reducing people’s real incomes and pushing up costs for firms,” she added.
The task of trying to tame inflation with lagging rate hikes is becoming more difficult as national governments pour stimulus funds into their economies to help consumers pay energy and other costs.
Partly as a result, “over the winter, it will become increasingly apparent that the Eurozone economy has entered a significant recession,” Berenberg bank’s analysts wrote in a research note last week.
The ECB will raise rates only twice more, ending them in February 2023 as the zone’s economy tumbles, ING analysts predicted.
Markets are now pricing in a top rate of 2.5 percent this year, scaling back their expectations from 2.8 percent after Lagarde spoke.
Lagarde’s message was “more cautious and less hawkish than in previous meetings,” Silvia Dall’Angelo, senior economist at investment firm Federated Hermes, told the Financial Times.
Last month, the bank’s post-meeting statement said it would boost rates “over the next several meetings;” in last week’s statement, it said only that it expects to “raise rates further.”
Instead of repeating that it was out to “damp demand,” it said it hopes to be “reducing support for demand.”
By raising rates, the bank also is hoping to make a category of special bank loans less attractive.
The loans were offered at a half-point discount from the bank’s deposit rate to encourage commercial banks to keep lending during the COVID War.
As of 23 November, the rate will no longer be special but will be set at the deposit rate.
As much as €600 billion of the loans could be repaid to the ECB by December, according to an ECB survey of participating banks.
That could boost money market interest rates by as much as a half-point, the FT noted.
Another bright spot: on news of the ECB’s rate hike, the euro’s value struggled back above $1.16. It had fallen to parity with the dollar on 12 July.
The euro’s fade has worsened inflation by making imports more expensive, particularly oil, natural gas, and refined products.
TRENDPOST: In “ECB Head Downplays Inflation” (25 May 2021) we noted that Lagarde dismissed inflation’s risk, saying higher prices “are of a temporary nature” and that inflation will ease back to modest levels in 2022.
“Underlying factors and fundamentals are certainly not there to let us… forecast that inflation will stay at these levels,” she said.
At the time, inflation in the Eurozone was 1.6 percent.
The central bank began raising rates far too late to have any meaningful direct impact on inflation.
Therefore, as we wrote in “ECB Raises Interest Rate By a Half-Point” (2 Aug 2022), the ECB’s new interest rate has more symbolic than practical value.
With the region’s inflation at 8.9 percent in July, an interest rate of zero can have no leverage against rising prices.
The bank’s unwillingness to begin to raise its rate until now has rendered it irrelevant to the fight against inflation.
TREND FORECAST: Because Europe’s economy never recovered from the COVID-era lockdown, the ECB delayed increasing its rate while businesses returned to financial health.
The wait was far too long.
Now the ECB will throttle back its rate hikes again as the continent slides into recession.
That will ensure the bank’s interest-rate maneuvers will have little to do with tamping down price increases.
Instead, high prices will reverse when consumers can no longer afford to spend and businesses are then unable to invest, a scenario now most likely to appear in winter or early spring as gas stores deplete and fuel prices rise again.