With the first interest rate hike in eleven years, Europe’s monetary authorities are reacting to the record inflation. The Governing Council of the European Central Bank (ECB) announced on Thursday that it intends to raise key interest rates in the euro area by 25 basis points each in July.
For the time being, however, the key interest rate will remain at the record low of zero percent, and banks will continue to have to pay 0.5 percent interest on parked funds with the ECB. ECB President Christine Lagarde had promised to end negative interest rates by the end of September.
At the same time, the ECB Council decided at its external meeting in Amsterdam to end the net bond purchases worth billions on July 1st. In its longer-term monetary policy outlook (“Forward Guidance”), the central bank had declared the end of these purchases as a prerequisite for an interest rate hike.
In the past few weeks, the pressure on Europe’s currency watchdogs has increased significantly, after years of the ultra-loose course, to change course and curb record high inflation with interest rate hikes.
In the euro zone, consumer prices in May 2022 were 8.1 percent higher than in the same month last year. According to preliminary figures, the annual inflation rate in Europe’s largest economy, Germany, jumped to 7.9 percent in May, the highest level in almost 50 years.
The ECB is aiming for medium-term stable prices with an annual inflation rate of 2 percent for the currency area of the 19 countries. Higher inflation rates reduce the purchasing power of consumers because they can then afford less for one euro. For months, inflation has been driven primarily by rising energy prices, which rose sharply again after the Russian attack on Ukraine. Problems in the supply chains are also causing prices to rise.
Before the ECB meeting on Thursday, economists were expecting a series of ECB interest rate hikes in the current year. By the end of the year, the deposit rate could rise to plus 0.5 percent and the main refinancing rate could reach a level of 0.75 percent.
Other central banks such as the Federal Reserve in the USA or the Bank of England have already raised their key interest rates several times. However, experience has shown that it will take a while for higher interest rates to reach savers.