Inflation risks reassessed: ECB raises key interest rate more than expected to 0.5 percent

The first rate hike by the European Central Bank in eleven years has been stronger than expected.

Inflation risks reassessed: ECB raises key interest rate more than expected to 0.5 percent

The first rate hike by the European Central Bank in eleven years has been stronger than expected. The key interest rate will be increased to 0.5 percent. There is no negative interest on parked funds. In addition, an anti-crisis program is presented.

Record inflation is forcing euro policymakers to step up the pace in their first rate hike in 11 years. Interest rates will rise by 0.50 percentage points, as announced by the central bank in Frankfurt. To the delight of savers, this eliminates the negative interest rate of minus 0.50 percent for parked funds from commercial banks. In recent years, many institutes have passed this burden on to private customers as a so-called custody fee. The key interest rate at which banks can borrow money from the ECB has risen from zero percent to 0.50 percent. The ECB announced further rate hikes for the next few meetings.

The Governing Council of the ECB had already initiated the change of course at its previous meeting in June, but held out the prospect of a smaller rate hike of 0.25 percentage points each time. "The ECB Governing Council considered it appropriate to take a larger first step towards normalizing interest rates than it announced at its last meeting," the central bank said. This decision is based on the ECB Governing Council's updated assessment of inflation risks.

Critics accuse the ECB of initiating the turnaround in interest rates far too late. Inflation in the euro zone has been rising to record levels for months. At the same time, the economic prospects have deteriorated due to the war in Ukraine. If the ECB raises interest rates too quickly in this environment, this could become a burden, especially for heavily indebted countries in Southern Europe.

In order to ensure that interest rate increases do not unduly burden countries such as Italy and to prevent fragmentation of the currency area, the ECB is launching a new anti-crisis program, the so-called Transmission Protection Instrument (TPI). "The TPI will complement the Governing Council's toolbox and can be activated to counteract unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy in the euro area," the central bank said. "The size of purchases under the TPI depends on the severity of the risks to monetary policy transmission. Purchases are not constrained a priori."

The ECB pushed ahead with work on this new anti-crisis instrument after unrest on the financial markets in mid-June. The yield gap - the spread - between government bonds from Germany and those of more heavily indebted euro countries, especially Italy, widened after the ECB announced a first interest rate hike in the summer. Means: For countries like Italy it will be more expensive to get fresh money. This could become a problem for such states in view of the already enormous mountains of debt. But persistently high inflation is forcing the ECB to act.

The process of normalizing monetary policy will be "resolutely and sustainably continued," said ECB President Christine Lagarde at the end of June. Other central banks such as the US Fed and the Bank of England have already raised their interest rates several times. In June, consumer prices in the euro area were 8.6 percent higher than in the same month last year.

For 2022 as a whole, the EU Commission expects inflation to average 7.6 percent in the currency area of ​​the 19 countries. That would be a historic high and far above the stable price level aimed for by the ECB with an annual inflation rate of two percent. Higher inflation reduces the purchasing power of consumers because they can then afford less for one euro. The drivers of inflation have been significantly higher energy and food prices for months. The Russian war of aggression in Ukraine has exacerbated the situation.

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