Saturday, December 10

The ECB raises interest rates by 0.75 points, to 2%, despite the risk of recession

The European Central Bank brushes off recession fears and raises its main interest rate to 2%, the highest level in more than a decade, since January 2009, to tackle record inflation in the euro zone. Thus, the entity chaired by Christine Lagarde has approved a second consecutive increase of 75 basis points.

“The Governing Council of the ECB has decided to raise the three official ECB interest rates by 75 basis points”, reports the entity: “With this third important consecutive rise in official rates, the Governing Council has made considerable progress in reversal of the monetary policy stance. The Governing Council has adopted this decision and plans to continue increasing interest rates to ensure the timely return of inflation to its medium-term target of 2%. The governing council will base the future path of official interest rates on the evolution of the outlook for inflation and the economy, continuing with its approach in which decisions are taken at each meeting”.

Consequently, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will increase to 2%, 2.25% and 1.5%, respectively, with effect from November 2, 2022.

According to the ECB, “inflation remains excessively high and will remain above target for an extended period. In September, inflation in the euro area stood at 9.9%. In recent months, escalating energy and food prices, supply bottlenecks and a post-pandemic recovery in demand have led to widespread price pressures and increased of inflation. The monetary policy of the Governing Council is geared towards reducing support for demand and providing protection against the risk of a persistent upward shift in inflation expectations”.

The bank’s argument is that, with almost 10% in the eurozone, it is five times the ECB’s medium-term target of 2%, and getting back to that level takes precedence over protecting the economy from an energy-driven recession this winter.

After the euro’s pullback, the ECB is also under pressure to match the Federal Reserve’s aggressive rate hike. Hardline members of the ECB Governing Council, such as Germany’s Joachim Nagel, insist that rates must continue to rise, despite the looming recession, because inflation is alarmingly fast.

The pace of increases is likely to slow to 50 basis points in December, according to economists polled by Bloomberg, who forecast two more steps of half that magnitude before the top is reached.

record inflation

Inflation set a new record in September. Eurostat confirmed the anticipated trend three weeks ago, and puts year-on-year inflation for September at 9.9% –one point more than that registered in Spain–, compared to 9.1% in August. In September 2021, the rate was 3.4%.

September thus becomes the month with the highest year-on-year inflation, after the increase in prices was 5.1% in January; 5.9% in February; 7.4% in March and April; 8.1% in May; 8.6% in June; 8.9% in July; and 9.1% in August.

Likewise, inflation in the EU 27 was 10.9% in September 2022, compared to 10.1% in August. A year earlier, the rate was 3.6%.

The lowest interannual rates were registered in France (6.2%), Malta (7.4%) and Finland (8.4%). In Spain, the rate stood at 8.9% in September, according to the INE –although the Eurostat data maintains a preliminary 9%– compared to 10.5% in August, and it is one of the six countries where the inflation fell last month.

The highest rates, on the other hand, were registered in Estonia (24.1%), Lithuania (22.5%) and Latvia (22.0%). Compared to August, annual inflation fell in six Member States, remained stable in one and increased in 20.

The ECB has also decided to cap the profits of banks that are profiting extraordinarily from higher rates. Thus, it has decided to modify the conditions of the third series of longer-term financing operations with a specific objective (TLTRO III). “During the acute phase of the pandemic, this instrument was essential to counteract the risks to price stability”, states the ECB: “Currently, in view of the unexpected and extraordinary increase in inflation, it is necessary to recalibrate it so that it is consistent with the broader process of monetary policy normalization and to strengthen the transmission of increases in official interest rates to bank financing conditions. Consequently, the governing council has decided to adjust the interest rates applicable to TLTRO III as of November 23, 2022 and offer credit institutions additional dates for voluntary early repayment of these operations. From November 23, 2022 until the expiration date or the date of early repayment of the corresponding current TLTRO III operation, the interest rate applicable to TLTRO III operations will be indexed to the average during that period of the official interest rates of the Applicable ECB. The Governing Council has also decided offer credit institutions additional dates for voluntary early repayments. In any case, the Governing Council will periodically evaluate the way in which the financing operations with a specific objective are contributing to the orientation of its monetary policy”.

In addition, “in order to more closely align the remuneration of the minimum reserves held by credit institutions in the Eurosystem with the conditions of the money markets, the Governing Council has decided to set the remuneration of the minimum reserves at the interest rate of the ECB deposit facility.