The high inflation is forcing the ECB to correct its course. In July, she will initiate the turnaround in interest rates. The step is long overdue - but carries risks.
Inflation is very high. In the euro zone and in Germany it is now at the eight percent mark. The European Central Bank has nevertheless refused to raise interest rates for months. But now she feels compelled to pull the emergency brake. In all likelihood, the Governing Council of the ECB will remain silent at Thursday's meeting. But in July it will start - as it currently looks - to leave the zero line. A second interest rate step is to follow in September.
As unavoidable as the turnaround in interest rates is, it can have unpleasant side effects. The fact that the ECB delayed raising interest rates for as long as possible was not without reason. The most important: She had assumed that the high inflation rates were temporary. The supply chains disrupted by the corona pandemic would stutter again in the foreseeable future, and the supply bottlenecks would disappear. With the end of the heating season, energy prices would fall again. In addition, higher interest rates would not combat the reasons for rising inflation. They neither ensure functioning supply chains, nor do they make oil cheaper.
However, this assumption became obsolete at the latest when Russia invaded Ukraine at the end of February. Fueled by the war of aggression, energy prices rose sharply. And it is quite possible that they will continue to increase. In addition, the Chinese leadership's zero-Covid policy with tough lockdowns keeps messing up the supply chains.
The argument that raising interest rates doesn't help against these supply shocks hasn't changed. However, prices are now rising across the board. The ECB therefore sees itself forced to act. This is also due to the fact that a wage-price spiral is looming. The logic behind this: Workers across all industries are giving up their restraint and pushing through higher wages across the board, as they do not expect inflation to be back in the green any time soon. Companies raise prices to compensate. As a result, the general price level continues to rise, creating a chain reaction.
ECB inaction could contribute to this development. The fact that the ECB, under the leadership of Christine Lagarde, put off interest rate hikes is now taking its toll. The hesitancy may also result in the central bank having to raise interest rates more aggressively than is good for the economy in the face of persistent inflation. An earlier interest rate move could have helped to prevent inflation expectations from becoming entrenched - and now gave the ECB more leeway.
Raising interest rates is the classic remedy for inflation. They dampen prices by slowing down economic growth. And that's the problem with this tool: Aggregate demand falls as borrowing becomes more expensive and saving becomes more attractive. Companies invest less, consumers spend less money. This slows down the economy and tends to lead to higher unemployment. "It's a bit like hitting the entire economy with a hammer (in slow motion)," says the think tank "Future Department".
Higher interest rates aren't just an intricate way to fight inflation. They also work differently in different population groups. They tend to lead to job losses, making it more difficult to push through higher wages. This is particularly true for workers on fixed-term contracts or for the low-skilled. In the nursing professions, for delivery services or in the meat industry, for example, companies can more easily enforce lower wages.
So for people working in such industries, rate hikes can be rather bad. For civil servants and employees with permanent contracts and permanent jobs, they are irrelevant in this respect. They even benefit if they don't have to spend more money on their visit to the hairdresser or their pizza delivery. Another example: Higher interest rates are good news for savers. However, those who want to buy an apartment should not be particularly pleased.
That's not to say raising rates in September would be a mistake. The monetary policy of the ECB is therefore still very expansive. Monetary stability is also a valuable asset. It is the central banker's job to keep prices stable.
But interest rate hikes come at a price. In the first three months of the year, the euro zone economy grew by just 0.3 percent compared to the previous quarter. The Russian war of aggression will further dampen the economic recovery from the consequences of the corona pandemic. Since interest rate increases do not take effect immediately, but with a delay of between 12 and 18 months, this means: In the worst case, the steps would only take effect when the euro zone is already in recession due to a gas delivery stop by the Kremlin.