This is the first time since 2011. The European Central Bank (ECB) will raise interest rates in July. This was announced by its President Christine Lagarde on Wednesday. “After the first rate hike, the normalization process will be gradual,” said the leader, who has been talking about a phased “journey” since April, hinting at more rate hikes to follow after the first launch of the summer.
The decision is designed to fight inflation, reaching record levels in the eurozone. Stephanie Villers, an economist specializing in macroeconomics, explains 20 minutes the consequences of this measure.
What’s going on with the ECB?
The European Central Bank will conduct monetary tightening with an increase in interest rates. This increase follows the policies of other central banks such as the Fed, the American Central Bank or the Bank of England (BoE). In early May, the Fed raised the key rate by 0.5 points, and the Bank of England raised the rate to its highest level since 2009. It is assumed that this increase in interest rates will be aimed at fighting inflation. In April, it reached a record high of 7.5% for the year in the Eurozone and more than 8% in the US.
How does raising interest rates help fight inflation?
We’ve all heard real estate advice in life: “Now is the time to buy because the rates are low.” Well, the idea is to do the opposite: when interest rates are high, you don’t buy less, you don’t borrow less, whether at the household or business level. High interest rates make investment less attractive as it is more expensive to borrow, so investment is reduced, as are household production and purchases. We slow down the economy and thereby slow down inflation. As there is less demand, prices stabilize or decline.
We have to be careful not to raise rates too quickly and abruptly, because if the economy slows too much, it could lead to a recession. It’s a fair combination, which is why Christine Lagarde talks about raising rates, then bouncing back, then raising… It’s a delicate balance.
So is this a good solution to curb inflation in the eurozone?
There is a problem with this strategy regarding the eurozone. In these countries, inflation is associated with an increase in energy prices or prices for imported agricultural products, i.e. products purchased outside the euro area. Even if the ECB raises its interest rates, this will not change the price of Russian energy, so there is no certainty that inflation will come down. You must understand that we have some kind of external inflation, so it is more difficult to influence it.
In the United States, it is inflation driven mainly by wage increases. For once, raising interest rates has a real impact: companies will have fewer opportunities to invest, and therefore fewer employees, and therefore lower wages, which will affect inflation.
Is the ECB making a useless decision?
Still no. First, it will still affect, albeit to a lesser extent, inflation. Secondly, it again makes the euro more reliable against the dollar, which was favored after the Fed’s interest rate hike. The rich prefer to invest their money in the United States with better interest rates. In France, the current 10-year interest rate is 1.5%, while in the US it is 3%. It is inevitable that investing your money in the USA is much more profitable and profitable. The mission of the ECB is not to support the value of its currency, but he was not going to give up on this, and the fight against inflation is a very good excuse.
What does this change for households?
Getting a loan will be more expensive and more difficult. This has already begun: banks are becoming less flexible in their ability to issue loans: they ask for more guarantees, terms and less money to issue. Conversely, at high interest rates, savings run the risk of becoming more profitable. In particular, we may envisage a future increase in livery A to bring it in line with ECB interest rates. And more money means less consumption and therefore less inflation.