ALBUQUERQUE, New Mexico — On June 9, 2022, the EU Central Bank (ECB) announced that it would be raising its interest rates for the first time since 2011. The plan is an initial increase of 25 basis points or .25% on July 21 and then a subsequent rate hike in September. Currently, interest rates are actually negative as a part of a stimulus plan that has been in place since 2014. After the initial July rate hike, the EU’s deposit interest rate will stand at -.25%.
Europe’s Inflation Crisis
This is a response to rapidly rising inflation of the Euro as well as currencies globally. In May 2022, the Euro reached an inflation rate of 8.1%, the highest rate since the Eurozone’s inception. It is especially concerning considering the ECB has stated its aim is to have the inflation rate at 2%. This increased inflation rate comes in the wake of Russia’s invasion of Ukraine and the subsequent economic impact it has caused.
Fuel and food prices have skyrocketed, making it difficult for Europe’s lower and middle classes. It is also important to note that the Euro is not alone in regard to increased inflation rates, as currencies around the world are being devalued. The U.S. dollar reached an inflation rate of 8.6% in May 2022, its highest since December 1981.
Many economists have been calling for both the U.S.’s Federal Reserve and ECB to raise interest rates for months in hopes of proactively addressing inflation. Yet, both central banks acted out of caution and decided to wait. Now they have their work cut out for them to get inflation rates back down to a reasonable number.
The ECB faces an especially complex situation as the EU’s economy is more fragile since the ECB instituted negative interest rates in 2014. Any immediate changes in interest rates have more potential to throw the economy into a frenzy.
The ECB’s Response
The hope now is that the initial rate hike will cool down the increasing inflation rate enough that a higher rate hike of 50 basis points in September will not be necessary. Both economists and the ECB itself predict it likely will take multiple rate hikes later this year to reach the 2% goal.
Another factor in the ECB’s decision to raise EU interest rates is the current state of bond yields across southern EU member states. Europe’s “Fear Gauge,” the difference in German and Italian bond yields, rose to its highest level since May 2020, CNBC reported. This is a tool that those looking to analyze the state of the EU economy use.
Germany is the EU’s largest credit supplier while Italy is often one of the EU’s largest debtors. Italy’s 10-year bond yield rate rose above 4% on June 13, its highest rate since 2014. Meanwhile, Germany’s 10-year bond yield rate was at 1.638% on June 13. Although, Italian 10-year bond yield rates have since dropped back under 4% after the ECB’s emergency meeting on June 15. This is encouraging, but not unexpected due to the European markets’ current volatility.
Long Term Outlook of the Euro
As mentioned previously, the ECB’s plan is to raise interest rates in July before another potential rate hike in September. The ECB has even announced a potential third interest rate hike by the end of the year in hopes of reaching a “natural rate” believed to be 1.5% that would promote neither growth nor decline by 2023. As previously mentioned, the key is to get inflation rates as close to the 2% goal as possible, yet the EU’s central bank has stated it has no intention of rushing to meet that goal.
The EU’s economy is quite sensitive and the ECB is being very hesitant. Its fear is that raising rates too quickly could reverse inflation too suddenly and result in the need for a subsequent rate decrease soon after. This fluctuation would be too much for the aforementioned sensitive European economy and could have impactful consequences.
The announcement of an emergency ECB meeting alone caused the Euro’s value relative to the dollar to raise by 0.7% ahead of the opening of European markets on Wednesday, June 15.
The ECB’s hope is that the market’s sensitivity will lead to a swift decrease in inflation rates after the initial hike of EU interest rates scheduled for July 21.
– Devin Welsh