The European Central Bank (ECB) is preparing for one of the sharpest rate hikes since the introduction of the euro. The panel, chaired by Christine Lagarde, has already announced a 0.25% hike next July and another in September that could be as high as 0.5%. And he warns that this is just the beginning of an upward path that markets say could hit 2% by 2023. Some experts interviewed go even further. However, the end of the negative interest rate era has shown that when interest rates rise, it is crucial not to allow risk premia to skyrocket.
The US Federal Reserve’s interest rate hike, this time by 0.75%, increases the pressure on the ECB. Even Switzerland, with inflation at just 2.9%, decided on Thursday to raise interest rates by half a point for the first time in 15 years. And England took another step, adding 0.25%. The ECB is still lagging behind and has already announced the first hikes to calm the markets. However, investors immediately reacted violently to risk premiums from the periphery. Frankfurt reacted with adjusted reinvestments of maturing debts and with a new instrument to avoid debt crises, which is even regarded as essential for the continuation of monetary normalization. In fact, Deutsche Bank believes that this tool opens up an opportunity to tighten monetary policy more quickly from September.
But how far will interest rates go? Lagarde gave a hint on her blog. “If inflation stabilizes at 2% in the medium term, further gradual normalization of interest rates towards a neutral rate is appropriate,” he said. However, this gave rise to all kinds of speculation and calculations. A neutral interest rate is one that does not expand the economy, but it does not contract either. In other words, it allows him to develop according to his potential. “This is an issue that we deliberately chose not to address at this Governing Council meeting. I am sure we will discuss ad nauseam whether it is 0.96% or 1.97% or more, below or whatever,” the French said after the last ECB leadership meeting.
The growth question mark
Nevertheless, the members of the Governing Council have made their calculations. That pigeons are more by 1% while the hawks approve 2%. “The idea is to achieve a neutral course over time. I’ve seen that in Europe it’s estimated at between 1.25% and 1.5%, while in the United States it should be higher, around 2.5%,” says Francesco Papadia of the think tank Bruegel. The influential German Ifo goes even further. “Our hypothesis is that the ECB interest rate will be 2% at the end of 2023 and the 10-year Bund rate will be 2.5%. We believe these steps are the right ones to keep inflation and inflation expectations in check,” says Timo Wollmershüer, Head of Research and Outlook. However, the feeling is that the ECB is running late.
Currently, analysts are between 1% and 2% around the generous range drawn by Bank of France Governor François Villeroy de Galhau. Nomura expects euro-zone rates to hover around 1.25% next year, while Deutsche Bank expects them to be much more aggressive, hovering around 1.75% by the end of this year. Professor at the Graduate Institute of Geneva, Charles Wyplosz, goes much further and even believes that the Eurobank must reach or exceed 3% to fight inflation. However, an ECB member suggested that the pace and intensity of the increases should be in line with countries’ economic and financial situations. “What would happen if there was another one in the middle of the raises shock What hits the economy?” he asks. The other big variable, risk premia, was suppressed for now with the announcement of the new tool, although financial sources warn markets will soon be asking for details.
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