fight against inflation
ECB increases key interest rate by 0.75 percentage points
09/08/2022, 2:19 p.m
Inflation in the euro area climbed to a record high of 9.1 percent in August. The ECB wants to take a historic step to preserve purchasing power in the euro area: it decides on the largest interest rate hike since the introduction of euro cash.
The ECB is bracing itself against record inflation with the largest rate hike since the introduction of euro cash in 2002. The monetary authorities around ECB boss Christine Lagarde decided to increase the so-called main refinancing rate by three quarters of a percentage point to 1.25 percent. The currency watchdogs are reacting to the escalating inflation, which recently reached a high of 9.1 percent.
The economists at the ECB are now assuming an average inflation rate of 8.1 percent in the euro zone for the current year, as the ECB announced. As recently as June, the forecast was 6.8 percent. In 2023, inflation is expected to be 5.5 (June forecast: 3.5) percent and then drop to 2.3 (June forecast: 2.1) percent in 2024. “Price pressures have continued to gain strength and breadth across the economy,” the monetary authorities conceded. “Inflation continues to be driven by soaring energy and food prices, demand pressures in some sectors as the economy reopens and supply shortages.”
In view of the gas crisis and high inflation, the ECB sees gloomy economic prospects for the euro zone. The economy will slow down significantly, Lagarde said after the interest rate meeting in Frankfurt. Stagnation is to be expected later in the year and in the first quarter of 2023. This outlook is also reflected in the latest ECB staff projections for economic growth. They have been revised down significantly for the remainder of the current year and for 2023. Experts now expect growth of 3.1 percent for 2022, 0.9 percent for 2023 and 1.9 percent for 2024.
Many economists now believe it is possible that the economy in the euro area could slip into recession in the autumn due to the ongoing energy crisis as a result of the Ukraine war and the supply chain problems that have not yet been overcome. Recent economic data recently underpinned this fear. For example, the Purchasing Managers’ Index (PMI) for the private sector, which includes the industrial and service sectors, fell below the growth threshold of 50 points in August and thus to its lowest level in 18 months. In Germany, the largest economy in the euro area, the Ifo business climate index fell to its lowest value since June 2020 in August.
Concern about the brake on the economy is great
The monetary authorities last raised the key interest rate at which banks can borrow money from the ECB from 0 percent to 0.50 percent in July. Economists believe that significantly higher interest rates are necessary to fight inflation effectively. Inflation in the euro area climbed to a record high of 9.1 percent in August, driven by rising energy and food prices. Economists expect a further increase in the coming months. The ECB is aiming for a stable price level with annual inflation of 2 percent for the common currency area in the medium term.
At the international central bank conference in Jackson Hole, USA, at the end of August, ECB Executive Board member Isabel Schnabel warned against taking decisive action against persistently high inflation. “The longer inflation remains high, the greater the risk that the public will lose confidence in our determination and ability to maintain purchasing power,” Schnabel warned.
However, the monetary authorities are also concerned that the economy, which is already having to do with supply bottlenecks and the consequences of the Ukraine war, for example on the energy market, will be slowed down by normalizing the monetary policy, which had been ultra-loose for years, too quickly. The ECB therefore reserves the right to help heavily indebted euro states by buying bonds. The ECB had long interpreted the high inflation as temporary and initiated the turnaround in interest rates much later than many other central banks.