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ECB decisions, from rates to mortgages: the consequences

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ECB decisions, from rates to mortgages: the consequences

The ECB intervened after more than ten years with a hike in interest rates of half a percentage point. Faced with a worrying economic picture, with inflation dangerously close to double digits, Eurotower has opted for a decisive monetary tightening of 0.50% instead of the 0.25% that was credited until recently. The increase in the cost of money will have direct repercussions in the life of citizens and businesses, but not only.

Why the Central Bank raises rates

The interest rate can be defined as the main monetary policy tool of a central bank. The primary objective of the ECB is to maintain price stability, i.e. inflation around 2%. When inflation rises beyond the warning limits with all the ensuing consequences, first of all the loss of value of savings, the central bank intervenes by increasing the cost of money and, therefore, reducing the availability of money in circulation. This means less expenses, therefore less demand, but also less investment, with the risk of slowing growth in order to bring down the uncontrolled increase in prices.

More expensive loans and mortgages

The increase in central bank rates affects the general level of interest rates. Hence the general level of the cost of money. If eurozone banks pay a higher cost to borrow money from the ECB, in the end, loans and variable rate loans (mortgages) to businesses and citizens will also be more expensive. The reference parameter for variable rate mortgages is the Euribor which, like other interbank interest rates, is very sensitive to changes in the ECB rate. Furthermore, the increases for citizens and businesses could be greater in some countries, such as Italy, if the central bank does not avoid the return of the fragmentation of the European market already seen in recent years. A signal to this effect has already arrived from the increase in the spread between Italian BTPs and German Bunds which measures, albeit in an approximate manner, the country’s level of risk. If for a mortgage the reference parameter is not the spread, but the Euribor, however a greater spread weakens the banks, which are therefore more prudent in disbursing loans or granting them at higher rates.

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Higher cost of public debt

If the rates rise, the states that issue debt securities to finance themselves will have to offer them with higher interest rates, otherwise the markets could move towards other more profitable instruments. This could lead to a worsening of the situation for those countries that are already heavily indebted, such as Italy, net of central bank interventions, similar to the already seen quantitative easing, to keep spreads low. However, it must be said that, in the case of Italy, a high average duration of the debt, equal to about seven years, with over 70% at a fixed rate, curbs the repercussions of an increase in rates and, therefore, of the spread. Another consequence is the loss in value of the bonds previously issued, as they are less profitable than those newly placed and, therefore, less attractive on the market.

Strengthening of the currency

The monetary tightening also results in a strengthening of the euro exchange rate which, at the moment, is hovering around parity with the dollar. The strengthening of the dollar, which we have seen in recent months, is a consequence of the aggressive series of rate hikes carried out by the Federal Reserve. A weak currency favors tourism and exports but, on the contrary, penalizes those countries that import many goods, especially raw materials.

Slowing of growth

The general risk of a monetary tightening is that of a slowdown in growth, due to a contraction in consumption and investments by companies. But, on the other hand, it should be noted that the consequences of runaway inflation can be much more serious.

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