The European Central Bank (ECB) announced Thursday that it will raise interest rates next month. It is the first time in eleven years that this has happened. The aim is to curb high inflation. Five questions for APG's Chief Economist Thijs Knaap and Senior Strategist Charles Kalshoven.
Isn't the ECB a little late with this?
“In hindsight, certainly. Inflation has been way too high since last summer. Of course, it was not unreasonable for the ECB to initially estimate that inflation would fall again soon. A lot of inflation was related to startup problems after all the lockdowns. But yes, Ukraine has now been added, with a major impact on energy and food prices. There were also new lockdowns in a number of large production centers in China. It is clear that inflation will therefore remain high for longer. Other central banks have intervened before (such as the US and the UK) but you can argue that inflation in the Eurozone has so far been the result of external shocks, which the ECB cannot do much about.”
Why is the ECB taking the plunge now and not before?
“President Christine Lagarde herself previously indicated that the ECB would stop buying bonds in the third quarter. And that interest rate hikes would only come after that. To avoid unrest, the ECB wanted to be predictable and not to surprise the market. The disadvantage of this late intervention is that the interest rate will rise somewhat faster after this. Lagarde hinted that after a quarter of a percentage point hike in July, interest rates could rise by half a percentage point in September.”
Is there anything to say about how long it will take a rate hike to bring inflation back to the desired 2 percent?
“The ECB itself always talks about a pass-through of interest rate steps that is 'long and variable', one and a half to two years. But these are just the first steps now. Inflation is expected to remain high this year and next. The ECB itself thinks that inflation will be back at 2.1% in 2024. Market expectations based on traded inflation are somewhat above that. Where we arrive with the interest rate when inflation is stable is known among economists as the neutral rate. In a recent message on the ECB's website, Lagarde indicates that she expects the ECB to move slowly towards this neutral rate. But at the same time she indicates that no one knows exactly how high this interest is. So there is not much to say about it.”
Is this hold enough to bring inflation back?
“It will take a little more than just the announced interest rate steps of July and September. The ECB itself is also talking about the start of a process. It is true that the ECB can get help from a number of quarters. A recession would depress wages and energy prices. More pleasant – and less likely – would be: relaxation in the oil market due to rapid peace in Ukraine. Another possibility is that governments will interfere with prices. Think of subsidies or maximum prices. That is quite disruptive economically, so let's hope these weapons are not used too much. Ultimately, you also need some time to work inflation out of your system.”
It is the ECB's first rate hike in 11 years. How unique is this?
“Especially what you see in the rear-view mirror is unique. We have had ten years in which the ECB interest rate was zero or negative. The latter was not possible at all according to the economic textbooks. Mario Draghi was president of the ECB for eight years but never raised interest rates. His successor probably does. We're finally going back to normal. Borrowing money will cost money again, storing money will pay off again.”