There he was, Thursday, the first interest rate hike of the major western central banks. The Bank of England raised interest rates from 0.1 to 0.25%. A small step, but a clear signal: we see current inflation as a problem – and we are taking action. The day before, the US Federal Reserve had also given such a signal. She has forecast three rate hikes for 2022 and is phasing out the purchase of government debt, with which the Fed is depressing capital market rates.
And the European Central Bank? It will raise interest rates in 2023 at the earliest, according to the decisions taken by the ECB board on Thursday. Very slowly, the purchase of government and corporate bonds first falls – and only then can the extremely low interest rates in the eurozone (0 percent for banks that borrow money from the ECB, -0.5 percent for banks that deposit money) go up again .
Wish
The ECB is remarkably more cautious than the other two banks. This while the inflation boom is playing everywhere. The US clearly leads the way, with 6.8 percent inflation. But inflation in the United Kingdom and the eurozone is also high, at around 5 percent. Central banks mainly look at the expected inflation in the coming years. It should reach 2 percent, and stay there. According to the ECB, the price increases will already wear off next year. The Fed and the Bank of England are less reassured about this.
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The ECB expects that inflation will be 3.2 percent next year, to fall to 1.8 percent in the next two years. Two-thirds of inflation in 2022 will come from energy prices, said Christine Lagarde, the ECB chief. They will stabilize again, she predicted. She admitted that there is “uncertainty” about this.
The ECB’s relatively calm response to inflation prompted three of the 25 ECB board members to object to Thursday’s decision: outgoing President of the German Bundesbank Jens Weidmann, plus his colleagues from Belgium and Austria. Klaas Knot, president of De Nederlandsche Bank, had argued in recent months for a reduction in bond purchases towards zero. He saw this wish sufficiently reflected in the final decision.
What exactly will the ECB do? At the end of March, the ‘pandemic emergency buyout program’ will be terminated. Under this program, the bank still buys just under 80 billion euros a month in government and corporate debt. To avoid an abrupt rise in capital market interest rates, the ECB is taking a series of mitigating measures. The bonds from the pandemic program that expire will be replaced by new ones, until 2024 – a year longer than previously anticipated. The regular purchase program will also be temporarily increased. It will go from 20 billion in monthly purchases now to 40 billion in the second quarter of 2022. After that, those purchases will also decrease, to 20 billion in the last quarter.
For another year, the ECB will continue to push interest rates down with the purchase of debt, which makes borrowing cheap for governments (including for the Rutte IV cabinet) and for companies. In times of crisis, these policies were supposed to keep the economy going and help governments. Now the ECB runs the risk of falling behind.
Surprised by the level of inflation
For months, central bankers have been surprised by the height and duration of inflation. A crucial question is whether the price increases will feed through into higher wage demands – and higher wages. This makes production more expensive, further increasing inflation (a ‘wage-price spiral’). According to Lagarde, there are no signs of wage increases. But wages often lag behind inflation, for example in the Netherlands, where collective labor agreements are laid down for a longer period of time. Those wage increases could suddenly start to follow in 2022 – and then inflation could turn out higher.
Greece had a special role in the two-day meeting. That country’s government bonds have such a low credit status that they do not qualify for the regular ECB buying programs. The ECB made an exception for the pandemic buying program, and the associated purchases of Greek government bonds kept prices high and interest rates correspondingly low. Now that the ECB’s pandemic program has come to an end, the bottom of Greek government bonds threatens to disappear, resulting in sharply rising interest rates.
Preventing new turmoil around Greece was one of the reasons for the decision to replace bonds that expire in the emergency program with new ones for longer. Part of the money released does not have to be reinvested in government bonds of the country concerned, but can also be invested in Greek loans, the decision explicitly states.
This policy touches on an underlying goal of the ECB’s monetary policy: to keep the interest rates on government bonds of euro countries close together. If those interest rates diverge too much, there is a risk of fragmentation of the eurozone, and of the euro itself. Thus, when it comes down to it, the ECB is not only concerned with inflation, but also always with the stability of the European currency. whatever it takesLagarde’s predecessor, current Italian Prime Minister Mario Draghi, is said to have said.
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