The European Central Bank (ECB) and its President Christine Lagarde will decide again this Thursday whether to increase key interest rates. Picture Alliance
The European Central Bank (ECB) faces one of its most important decisions on the key interest rate in the euro zone on Thursday.
Stubborn inflation argues for another interest rate hike. But Europe’s economy is on the brink of recession. That speaks for a break in interest rates.
Here are the arguments for and against another interest rate hike – and the possible consequences for your money.
The ECB has increased its key interest rate nine times since July 2022. Now the European Central Bank faces its most important and sensitive decision in this interest rate cycle. Inflation in Europe is stubbornly high. So should the ECB follow up with a tenth interest rate hike? Or would it be wise to at least take a break from interest rates because Europe’s economy is on the verge of recession? Will the ECB succeed in a “soft landing”, i.e. curbing inflation without crashing the economy?
On Thursday, the ECB Council headed by President Christine Lagarde has to make a decision. The tension has rarely been so great. Council members avoid any suggestion of how they might decide. There is no clear expectation among economists, in the financial markets and among ECB observers.
The key interest rate is a powerful instrument. The ECB’s decision has consequences for interest rates, prices and the economy. The euro is just as affected as savers and investors, borrowers and builders. Here are the most important arguments for and against an interest rate increase by the ECB as well as the most important consequences for your money.
Initial situation: stubborn inflation
By law, the ECB is only committed to monetary stability – not to growth. Nevertheless, the effects of interest rate increases on the economy play an important role in their decisions.
Inflation has passed its peak. Overall, however, it is only declining slowly. In August, the inflation rate for the euro zone remained at 5.3 percent. There are big differences. In Belgium and Spain it was only 2.4 percent, in Slovakia 9.6 percent. The core rate of inflation excluding the fluctuating prices for energy and food fell from 5.5 to 5.3 percent in the euro zone.
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In Germany, the national inflation rate is noticeably higher at 6.1 percent. As the largest economy, Germany is driving up inflation in the euro zone. On the other hand, there is a lot of data that suggests that the inflation rate, especially in Germany, will fall significantly in the coming weeks and months.
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Initial situation: the economy is on the brink
Interest rate increases dampen prices via the economic route. Higher interest rates make investments more expensive and saving relatively more attractive than consumption. So they dampen demand. One problem is that interest rate increases only take effect after a long delay. Economists assume that the interest rate hikes of the past few months are now significantly slowing down the economy.
This was also noted by the EU Commission on Monday, which lowered its forecast for the economy and referred to the ECB’s interest rate increases: “Meanwhile, the sharp slowdown in the provision of bank loans to the economy shows that the tightening of monetary policy is having an impact on the economy .”
The economy is barely growing in the entire euro area. The Commission only expects mini-growth of 0.8 percent for the EU. At the bottom of the list, Germany, economic output shrank by 0.4 percent. There have recently been calls among economists that the ECB should now leave interest rates unchanged and first analyze the effect of its previous interest rate increases.
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This is how much the ECB has increased the key interest rate
The ECB initiated the interest rate turnaround later than other central banks such as the US Fed. Since July 2022, the ECB has increased its key interest rates by a total of 4.25 percentage points at each of the following nine monetary policy meetings. These were the largest interest rate increases since the introduction of the euro.
The deposit rate at which banks can deposit money with the central bank is now 3.75 percent. The refinancing rate at which banks can borrow money from the ECB is 4.25 percent.
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The following graphic makes it clear that the ECB raised interest rates later and not as much as the US Fed. The key interest rate there is now over five percent. The Fed decides on the key interest rate in the USA a week after the ECB. Before that, important data on inflation in the USA will come this Wednesday.
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This is what analysts expect from the ECB meeting:
Before making interest rate decisions, the Reuters and Bloomberg agencies ask experts about their expectations. Opinions have rarely been so balanced. Reuters surveyed 69 economists. 39 of them expect the ECB to leave interest rates unchanged on Thursday. 30 economists expect interest rates to rise by 0.25 percentage points. Key interest rates then rose to their highest level since the start of monetary union in 1999.
The Bloomberg survey of 39 economists revealed a similar picture. The narrow majority of 20 experts expect an interest rate break, 19 expect an interest rate increase.
Observers largely agree that if the ECB foregoes an interest rate increase, this does not mean that the interest rate peak has been reached. In any case, the ECB will remain open to raising the key interest rate again later in the year. The Fed took a similar approach in the USA.
On hold: US dollars, euros and the stock exchanges
The great uncertainty before the ECB meeting has led to a wait-and-see attitude on the stock exchanges. On the one hand, more defensive stocks were in demand at the beginning of the week. Across Europe, banks and real estate stocks were very popular with investors before the ECB decision. However, the experts at Landesbank Hessen-Thüringen (Helaba) see the risk that prices could fluctuate more strongly before the ECB decision.
The same applies to the foreign exchange markets. The exchange rate of the euro and the dollar also reflects the interest rate difference between the two economic areas. The euro had risen sharply since its low against the US dollar in the summer of 2022 with the ECB’s interest rate increases. Recently, however, the dollar benefited from the strong US economic data compared to the euro zone.
“If the ECB takes another interest rate step, a slight strengthening of the euro can be expected,” said investment strategist Ulrich Stephan from Deutsche Bank.HE DOES”. But only then. Conversely, a pause in interest rates in Europe is likely to weaken the euro.
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ECB and key interest rates: This is what happens for savers and borrowers
For savers and investors, the interest rate increases have ended the long period of suffering from very low, sometimes negative, interest rates. Banks pay a top interest rate of 4.5 percent for fixed-term deposits with a one-year term. Daily money accounts also generate interest again. However, interest rates are still below the inflation rate. So the real interest rate is negative.
Due to the rapid interest rate increases and the emerging expectation of interest rate cuts over the next year, a special situation arises for fixed-term deposits. Some banks are willing to pay savers the same interest rate for one-year fixed-term deposits as for two-year fixed-term deposits. Normally, longer-term fixed deposits have higher interest rates.
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The situation for borrowers is completely different: “The interest rates for installment loans have increased by an average of almost three percentage points in the past twelve months and have reached a 14-year high,” writes Sebastian Schick from the finance portal Biallo. “There are loud calls for three-year loans Biallo-Index An average interest rate of 8.94 percent effective per year is due (as of July 14).”
Conclusion: What is the ECB doing with the key interest rate?
Two scenarios are emerging for the ECB’s decision on Thursday: The ECB increases interest rates by 0.25 percentage points and at the same time indicates a break in interest rates for the fall. Or the ECB is now leaving interest rates unchanged, but making it clear that it could raise the key interest rate further in the fall. According to many experts, how the markets react will then depend more on the accompanying communication than on the interest rate decision itself.
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