Caught up by inflation records, the European Central Bank (ECB) sent a strong signal on Thursday 8 September by accelerating the tightening of its monetary policy. The Board of Governors of the Monetary Institute decided to raise key rates by 75 basis points, a first in two decades of existence – apart from a technical adjustment in 1999.
Serving as a reference in a context of abundant liquidity, the rate on bank deposits at the ECB, reduced from −0.5% to 0% in July, thus fell to 0.75%. The other two key rates, the one applied to banks on refinancing operations over several weeks and the one targeting the day-to-day marginal lending facility, go to 1.25% and 1.50% respectively. These rate increases should encourage savings and reduce consumption, to reduce pressure on prices.
The euro zone risks a “recession” for the year 2023 in case of “total cut” Russian gas deliveries, ECB President Christine Lagarde warned at a press conference. A “pessimistic scenario” forecast prepared by the monetary institution, “including a total cut off of Russian gas supplies”in advance “a recession for 2023”she said. ” We are almost there “ after the closure of the Nord Stream gas pipelineadded M.me Lagarde.
Strong inflation for a long time
In July, the ECB had a firm hand by announcing a surprise increase of 50 basis points, when 25 points were expected. This first rise in more than a decade came after a long period of cheap money helping to stimulate the economy. The promise was then to do the same in September unless inflationary pressures ebb.
Gold prices rose in August to a record level of 9.1% over one year in the euro zone, well above the rate of 2% targeted by the ECB. The new tensions in energy prices since the complete halt in the supply of Russian gas to Europe even presage double-digit inflation in the fall. The hoped-for decline in prices will therefore be long overdue, as evidenced by the new inflation forecasts unveiled on Thursday, significantly raised until 2024.
The aggregate, according to the ECB, should rise to 8.1% in 2022, before slowing to 5.5% in 2023 and 2.3% in 2024. GDP growth is still expected at 3. 1% this year, before plunging to 0.9% in 2023, much less than expected in the last set of projections published in June.
hard line
More inflation and less growth: it is in this darkened context that the hard line defended in particular by the German Isabel Schnabel, an influential member of the executive board of the ECB, weighed on the decisions of the day. You have to demonstrate ” determination “ in the face of unbridled prices and this “even at the risk of weaker growth and higher unemployment”urged M.me Schnabel at the end of August. What matters is that the public keeps the “Confidence in our ability to preserve purchasing power”she insisted.
Until then, the dilemma between rising prices and fears of recession has held back action by the ECB, while other major central banks have started their rate-tightening cycle. Within the Governing Council of the ECB, a fraction of decision-makers defended an action “gradual” in terms of rate hikes, led by chief economist Philip Lane. But this clan turned out to be in the minority even though the batch of alarming news was piling up in the euro zone.
The weakness of the euro, which sank below the $0.99 threshold on Monday, could have been another argument for a monetary hammer blow. A weak euro increases the cost of imported products, which fuels inflation.
US Federal Reserve (Fed) rates are already between 2.25 and 2.50% and a 75 basis point hike is looming on September 21st. The Fed must act firmly against inflation, in order to avoid the painful consequences for households of prices which would continue to escalate, as in the late 1970s and the beginning of the 1980s, its chairman, Jerome Powell, said Thursday. “We think we can avoid the kind of very high social costs” that the Fed had, at the time, “had to impose to bring down inflation and establish a long period of price stability”, added the president of the American central bank during the annual monetary conference of the Cato Institute. The United States experienced a period of very high inflation in the 1970s, and this until the beginning of the 1980s. The rise in prices had been close to 15% over one year.
Concerning the ECB, this September tightening calls for others during the two meetings to follow before the end of the year, according to observers. However, an aggressive sequence by the ECB on its rates will increase the borrowing conditions of countries in the euro zone deemed vulnerable, such as Italy. The institute may have to draw sooner or later its new tool, presented this summer, intended to nip speculative attacks on debt in the bud, according to Holger Schmieding, economist at Berenberg.