The European Central Bank (ECB) raises rates and promises to do more in upcoming meetings

The European Central Bank (ECB) raises rates and promises to do more in upcoming meetings

Amundi Special Flash – ECB Rate Hike Update

Until recently, monetary policy interested only a small number of experts and financial market participants, who scrutinized the subtle nuances of central bankers’ words in an attempt to decipher the messages with their future decisions. The Covid-19 pandemic, a significant rise in inflation due to supply chain bottlenecks, and geopolitical tensions all contributed to a notable shift in monetary and fiscal policies. As a result, central banks are in the spotlight, especially in developed markets.

On Thursday, September 8, 2022, the Governing Council of the ECB decided to raise its reference rate by 75 basis points(1). This increase follows the 50 basis point increase on July 27, 2022 and takes the reference rate to its highest level since 2011(2).
During the press conference after the monetary policy meeting, the president of the ECB, Christine Lagarde, explained that the decision had been taken unanimously by the members of the Governing Council in an attempt to control inflation, which is persistently maintained by above the ECB’s target(3).

The main objective of the ECB is to maintain price stability and therefore control inflation. The ECB has a specific inflation target, set at 2%. This goal is important for multiple reasons: Low inflation means that people can easily plan their savings and spending, knowing that the purchasing power of their money won’t change significantly from year to year.

In addition, the 2% inflation target provides a safety margin against the risk of deflation and leaves room to adjust to variations in inflation rates in the eurozone countries.

Why is the ECB so interested in keeping inflation in check? Specifically, an increase in prices means that we can buy fewer goods and services with the same amount of money. In particular, the goods that we all need, such as energy and food, tend to have more “sensitive” prices and therefore experience more pronounced increases in a shorter period of time. This has negative repercussions, especially for the most vulnerable parts of our societies.

The situation in the euro zone is serious. ECB staff have updated their projections. They now expect inflation to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 20243. Inflation is driven by rising energy and food prices, strong demand for services and persistent bottlenecks in supply chains. Inflation could continue to rise in the short term.

Economic growth will also slow. The new projections have been revised downward for this year and next. The ECB now expects the eurozone economy to grow by 3.1% in 2022, 0.9% in 2023 and 1.9% in 20243. This year’s drop is due to inflation holding back spending and production, weakening global demand and high levels of uncertainty.

To deal with this complex situation and try to reduce inflation, we can reasonably expect the ECB to continue raising its rates, maintaining its muscle tone in the coming months. Ms. Lagarde also indicated that increases were expected during “several upcoming meetings”. Asked about the number that was hidden behind these “several”, she Lagarde indicated that “it would probably be more than two, counting this one, but probably less than five” 3. Regarding the determination of the neutral rate for the ECB, Ms Lagarde provided little guidance, saying that the ECB would maintain a data-driven approach as the meetings progressed.

“There was a time, not long ago, when central banking was considered quite boring and uninteresting. […] Some felt that monetary policy could be put on autopilot. I can say with confidence that those days are over”, said the then president of the European Central Bank, Mario Draghi4, in 2013. Years have passed, but this phrase, in relation to the financial crisis of 2011, is still relevant.

(1) Source: European Central Bank, Monetary Policy Decisions, September 8, 2022
(2) Source: European Central Bank, Monetary Policy Decisions, July 27, 2022
(3) Source: European Central Bank, Press Conference, September 8, 2022
(4) Speech by Mario Draghi, President of the ECB, in the “Debate Room” of the SEFA Studies Association and the Faculty of Economics and Business of the University of Amsterdam, April 15, 2013.

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