In July, the ECB initiated the turnaround in interest rates in the fight once morest inflation – far too late for some observers. In doing so, it raised the key rates by a strong 0.50 percentage points, contrary to what had previously been promised. The key interest rate was thus 0.50 percent. It was the first rate hike in over 11 years.
Since then, the inflation outlook has continued to deteriorate. According to estimates by many economists, inflation in the euro area might even rise to over ten percent in the coming months if food and energy prices continue to rise.
Prolonged high inflation warnings
Isabel Schnabel, a member of the ECB board of directors, recently called on her central bank colleagues to bring inflation back to the target value of two percent quickly and resolutely. In August, the annual inflation rate in the euro zone climbed to 9.1 percent, the highest since the euro was introduced. Therefore, the central bank basically has little choice but to further normalize monetary policy, said Schnabel.
“There is a risk that the phase of high inflation will last longer and that the current wave of inflation will only subside slowly,” warned the German Bundesbank President Joachim Nagel. He therefore called for a “heavy” interest rate hike.
Model USA and Canada
The ECB therefore followed the example of the US Federal Reserve on Thursday, which recently raised the key interest rate once more by 0.75 points. Overall, the Fed has already raised its key interest rates by a total of 2.25 points this year, twice by 0.75 points each. Another significant step is expected at the next meeting in September. Fed Chairman Jerome Powell recently made it clear that fighting inflation is the top priority for the US Federal Reserve. The central bank is apparently willing to accept the economic damage caused by rising interest rates.
The Canadian central bank is also continuing to take resolute action once morest inflation. The Bank of Canada announced on Wednesday that interest rates would be raised by 0.75 points to 3.25 percent. In July, the central bank raised the key interest rate by one percentage point. That was the sharpest increase since 1998.
Weakening economy as a problem
In Europe, the weak euro is making it more difficult to fight inflation. The euro recently fell below par with the US dollar and was trading at its lowest rate in almost 20 years. Crude oil and many commodities must be paid for in dollars. A stronger dollar makes imports more expensive and drives up inflation in the euro area. However, rising ECB interest rates might support the euro exchange rate.
However, monetary policy is made more difficult by the weakening economy. In particular, the sharp rise in natural gas prices, but also ongoing disruptions in the supply chain, are having a negative impact on economic development.
Rising key interest rates not only cool demand via more expensive loans and thus dampen inflation, they might also further slow down economic development. Like the Fed, the ECB might initially accept this risk. However, should Europe actually slide into recession, opponents of interest rate hikes might gain momentum once more.
Harder times for borrowers
For borrowers with variable loans, times are likely to get tougher with the ECB decision. It can be assumed “that those who have variable loans and also do not have a corresponding income will now be burdened,” said FMA board member Helmut Ettl. “It will be harder for some.”
“We have been warning of this for years,” added FMA board member Eduard Müller. This is exactly why the stricter rules for the granting of home loans were introduced, emphasized Ettl and Müller. The board members did not want to make any forecast as to whether there would be more bankruptcies among private companies as a result of a higher burden. However, the heads of the Austrian Financial Market Authority do not fear that higher interest rates will be fatal to the banks with regard to long-term lending.
