The President of the ECB, Christine Lagarde, hinted on Thursday that interest rate hikes are ahead in the euro area, as a recession alone is not enough to curb the rise in prices.
of the United States the strengthening of the dollar in relation to the common currency, the euro, increases the pressure on the European Central Bank to continue tightening monetary policy.
On Wednesday, the euro weakened again against the dollar, when the US central bank hinted that it might raise the key interest rate a little less in December.
Due to the weakened currency, products imported from outside the euro area become even more expensive. In other words, inflation is accelerating.
The European Central Bank (ECB) has emphasized several times that it does not have an exchange rate target, but it still takes into account the effect of the value of the euro on the development of inflation.
“The exchange rate clearly matters, which must be taken into account in our inflation forecasts,” said the CEO Christine Lagarde on Thursday according to news agency Reuters.
Director General Lagarde also emphasized that the tightening of monetary policy by central banks is progressing at different speeds in the United States and the Eurozone, because the state of the economy is different.
In the United States, the economy is overheated because the demand for labor is greater than the supply and the economy is operating at the extreme limits of its capacity. In the Eurozone, the economy is weaker because of the war of aggression started by Russia in Ukraine.
Lagarde implied that interest rate hikes will continue in the euro area. Lagarde, who visited Latvia, said According to the Financial Timesthat a “mild recession” is not enough to tame the rise in prices.
One a strong reason for the strengthening of the dollar is probably the fact that the risk of a recession in the euro area is greater than in the United States due to the energy crisis.
The value of one euro was 0.97 dollars on Thursday. A year ago, the value of the euro was 1.16 dollars.
“A weak currency increases inflationary pressure, so the ECB must take that into account. From the point of view of the US central bank, a strong dollar is a positive thing, because it slows down inflation,” says the chief analyst of the financial company Nordea Jan von Gerich.
A weak euro is not only a negative thing. At least in principle, the price competitiveness of the euro area’s export industry in international trade improves as a result of the weakening of the currency.
“The eurozone is a very open economy that depends on exports and imports. Partly because of this, the strengthening of the dollar accelerates inflation, and the ECB must also monitor the value of the currency when considering tightening monetary policy,” says the research director of the financial company Danske Bank Heidi Schauman.
of the United States the central bank started tightening monetary policy in March and has already raised the key interest rate six times this year. It has also resorted to an exceptionally large interest rate increase of 0.75 percentage points four times in a row.
The ECB, on the other hand, started tightening monetary policy in July with an interest rate increase of 0.50 percentage points. That was followed by strong rate hikes of 0.75 percentage points in September and last week.
The key interest rate of the US central bank is currently 4.00 percent and the corresponding deposit rate of the European Central Bank is 1.50 percent. Before July, the ECB deposit rate was -0.50 percent.
It is almost inevitable that both central banks will continue to tighten monetary policy at the end of the year and very likely next year as well. The number and magnitude of interest rate increases depend on how the economy develops in the coming months.
European the central bank will apparently say in December when it will start reducing the securities it buys from the market in its monetary stimulus programs. Most of the securities are government bonds that have been bought by the national central banks of the euro countries.
Investments in securities will decrease when central banks stop reinvesting the capital of maturing bonds.
“Basically, I would say that reducing securities holdings supports the euro. It is likely that the ECB will start shrinking bonds from its balance sheet more calmly than the US central bank. All signs point to the ECB wanting to withdraw from its exceptional measures,” says von Gerich.
The US Federal Reserve sells $60 billion worth of federal bonds and $35 billion worth of mortgage-backed securities every month.
“I’m not quite sure if the ECB will still announce the sale of securities in December. It is difficult to estimate the effect of possible sales on the value of the euro. Interest rate hikes are of greater importance to the value of the euro and, more broadly, to the transmission of monetary policy,” says Schauman.
Ultimate the reason for the tightening of monetary policy in the United States and the euro area is the increase in consumer prices, i.e. inflation.
According to preliminary data, inflation accelerated to 10.8 percent in the euro area in October. In the United States, it was 8.2 percent in September. Strong inflation is caused by supply disruptions in the global economy and high demand.
The International Monetary Fund (IMF) estimates that the economy of the euro area will grow by 0.5 percent next year, and the economy of the United States by 1.0 percent.
“Economic activity in the euro area has probably weakened significantly in the third quarter. We expect the weakening to continue at the end of the year and the beginning of next year. Rapid inflation shrinks people’s real incomes and raises costs for businesses, which reduces consumption and production,” CEO Lagarde said last week.
Despite the significant slowdown in economic growth caused by the energy crisis, the IMF urged central banks to focus strictly and steadily on taming inflation.
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