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Just how ‘early’ will the ECB start increasing interest rates?

By May 15, 2022No Comments


This five letter word caused a slight ripple this week for those who read the tea leaves on the utterances of central bankers.

Christine Lagarde, President of the European Central Bank, said in a speech in Slovenia that the bank’s purchases of bonds under its Asset Purchase Programme should conclude “early in the third quarter.”

She went on to say that this would mean an increase in interest rates “some time after.”

At the end of its Governing Council meeting in April, Madame Lagarde had stuck to the phrase that its Asset Purchase Programme “should be concluded in the third quarter” and that adjustments to its interest rates (yes, that does mean ‘increases’) “will take place some time after.”

I shall spare you the rabbit hole of speculation on what “some time after” actually means.

The good news (if you’re a borrower, maybe less so if you’re a saver…) is that Christine Lagarde also stuck to describing any further rate increases as a process that “will be gradual.”

Asset Purchase Programme

Firstly, the Asset Purchase Programme, is where the ECB goes into the market to buy up billions of euro in bonds.

This has the effect of making borrowing rates cheaper.

When it stops, the cost of borrowing in the euro area is likely to rise.

And then there are the interest rates set by the ECB.

The slow accretion of certainty helped by the use of the word “early” makes it almost sure now the ECB will increase rates at its July meeting.

It does also have a meeting in June, but from the signals so far, any rate move then would be a surprise.

Inflation across the euro area was estimated to have been 7.5% in April.

The ECB targets a 2% inflation rate
The ECB’s target rate is 2%. But it views its target rate at something that persists over the medium term.

If that sounds slightly ambiguous and not all that clear, then welcome to the world of central banking.

Inflation is not something that’s static.

It’s really not a ‘something’ at all but a barometer of thousands of purchases and transactions taking place across the economy over time.

When you fill your shopping trolley, you’re striking a price with hundreds of companies and the movement of those prices is what translates into inflation.

If there’s a certain level of inflation in the economy, then companies can expect to get more for their products in the future and will be keener to invest in new machinery, products and jobs.

Also, workers should have a reasonable expectation that their wages will rise so should be happier about spending their pay packets.

This is all in the happy 2% inflation world.

Unfortunately, that’s not the world we’re living in right now.

And it’s not just the euro area.

Inflation in the US was 8.3% in April, with more inflation across the economy generally than there is in Europe where energy prices are still the chief – but no longer the only – culprit.

Inflation in the UK is forecast by the Bank of England to hit 10% by the end of this year.

This all means we’re now at a juncture when central banks are more likely to be increasing interest rates than tinkering with all the other levers like bond purchases which helped economies and governments through the pandemic and kept borrowing rates low.

The Fed and Bank of England

Earlier this month, the US Federal Reserve increased rates by half of one per cent, its second rate rise this year.

Rates there are now in a range from 0.75-1%.

The Bank of England raised rates by 0.25% in May to 1%, its fourth such rate rise since December.

There’s a big debate in all three economies over whether rates should go up further and faster and whether inflation is under or out of control.

To add to the confusion, growth is slowing.

Growth in Europe is ‘losing momentum’
The ECB lowered its growth forecasts for the euro area in March and might do so again when its next set of forecasts are released in June.

Just this week, the OECD released its Composite Leading Indicators, which are a mixed bag of various statistics from industrial output to sentiment surveys meant to give an early indication of where economies are headed.

It said growth in Europe was “losing momentum”.

That might slow inflation, as that’s what usually happens when economies slow down.

However, as we all know well by now, a big chunk of the inflation being felt in Europe is down to energy and commodity prices.

And as Europe continues in its efforts to wrest itself away from reliance on Russian energy and commodities, there’s likely to be a fair whack of inflation that will come with that transition.

And it’s the kind of inflation that won’t be tamed by interest rates.

The ECB is coming late to the interest rate party.

And if growth does slow down significantly, it won’t be making up for lost time.

Let’s hope “gradual” doesn’t become the “grinding” we normally associate with recessions.

Article Source -Just how ‘early’ will the ECB start increasing interest rates? – RTERobert Shortt

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