The end of September should be over: Lagarde heralds the end of negative interest rates

The European Central Bank hesitated for a long time before reacting to persistently high inflation.

The end of September should be over: Lagarde heralds the end of negative interest rates

The European Central Bank hesitated for a long time before reacting to persistently high inflation. ECB boss Lagarde fears stalling the economy. But now the turning point has probably been decided: the era of negative interest rates should end in late summer. Critics say: Too late, too little.

According to its President Christine Lagarde, the European Central Bank (ECB) will end the era of negative interest rates in the monetary union by the end of September. "Based on the current outlook, we will likely be able to halt negative interest rates by the end of the third quarter," Lagarde wrote in a blog post on the ECB's website.

Bundesbank President Joachim Nagel described Lagarde's statements as a "right step forward" to reduce uncertainty and give the financial markets clear orientation. "Clear communication is absolutely important," said Nagel at a conference of the Austrian central bank. If inflation were as high as it is at the moment, central banks would also have to withdraw monetary policy support from the economy and - as in the euro zone - raise interest rates. According to him, this is a consensus in the Governing Council.

The deposit rate of the ECB is currently minus 0.5 percent and has been below zero since 2014 because the central bank wanted to use it to fight inflation that has been very low for a long time. This means that the banks have to pay fees for parking cash at the central bank, which the financial institutions have criticized as "penalty interest", which in some cases has also been passed on to savers.

Lagarde's statement gave the euro a boost, with the common currency climbing more than 1 percent to a four-week high of $1.0687. Higher interest rates make a currency more attractive to investors. Lagarde also opened the door for interest rates to continue rising. “Once inflation stabilizes at 2% over the medium term, a gradual further normalization of interest rates towards the neutral rate will be appropriate,” she wrote. However, the pace and scope cannot be determined in advance, since the economy is confronted with the corona wave in China and the consequences of the Ukraine war. "This creates more uncertainty about how quickly current pricing pressures are easing, how overcapacity is evolving and to what extent inflation expectations remain anchored at our target levels."

Higher interest rates make borrowing more expensive, which can dampen demand and limit inflation. On the financial markets, an increase in the key ECB interest rate, which has been zero for years, is expected for July. Nagel recently said that after an initial interest rate hike in the euro area, further hikes could quickly follow from his point of view. The ECB last raised interest rates in 2011.

According to ECB Council member Francois Villeroy de Galhau, rate hikes in July and September are essentially a done deal. "If you look at President Lagarde's statement this morning, the matter is probably over because there is a growing consensus," said the French central bank governor at a panel discussion at the World Economic Forum in Davos.

Critics say that doesn't go far enough. "ECB boss Christine Lagarde is bowing to the reality of stubbornly high inflation rates when she announces an end to the negative key interest rate for the third quarter and then an increase in the key interest rate towards the neutral level," commented Commerzbank chief economist Jörg Chandler. Since this neutral interest rate level is between 1.0 and 1.5 percent according to earlier statements by ECB representatives, he now expects a key rate increase of 0.25 percentage points at each of the next seven council meetings - until the ECB deposit rate in the spring of next year is 1.25 percent. "However, that shouldn't be enough to catch inflation again," said Kramer, since the neutral key interest rate is more between 2.5 and 3.0 percent.

The inflation rate in the monetary union is currently at a record high of 7.4 percent, as energy prices have skyrocketed after the Russian invasion of Ukraine. The ECB is actually aiming for a value of two percent. Because of the high inflation, Bundesbank boss Nagel expects an end to the moderate wage policy in Germany, which has been around for around ten years. "That time is over now," said Nagel.

You will probably see high numbers in Germany in the second half of the year in collective bargaining. But it is also no surprise that the unions were demanding higher wages in view of the rise in inflation. However, this does not necessarily have to lead to a wage-price spiral, which experts fear will lead to high inflation.

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