European Union: crucial days for monetary policy | Economy | D.W.

Inflation in the euro zone above 8 percent, the euro at the level of the dollar and a government crisis in Italy is the scenario in which the council of the European Central Bank (ECB) will meet this Thursday (21.07.2022) to decide on the future direction of monetary policy.

At the last board meeting in June, ECB President Christine Lagarde announced a reversal in interest rates, which would be the first in eleven years. After the interest rate Bases would rise 25 basis points initially (a basis point is one-hundredth of a percentage point), then likely rise 50 basis points in September. By then, the days of negative interest rates would be over. However, many banks are already reacting: in Germany alone, almost 50 banks have already phased them out completely, more are expected to follow in the coming weeks.

The ECB is late

But what everyone wants to know is how fast the ECB will raise interest rates. “The ECB is too late,” says Gertrud Traud, chief economist at Helaba, the regional bank in Hesse-Thuringia, Germany. In view of the historically high inflation rate, which is currently 8.6% in the euro zone, Traud describes the situation as “precarious”: “All over the world, central banks have already raised interest rates, now the ECB must also show that it is serious about its work and that it is fighting inflation”.

Headquarters of the European Central Bank (ECB), in Frankfurt, Germany.

Headquarters of the European Central Bank (ECB), in Frankfurt, Germany.

The pace and scope of monetary policy normalization is controversial, even on ECB advice. Bundesbank President Joachim Nagel can even imagine raising key interest rates within the restrictive range, which would actively slow down the economy. Nagel is often one of the proponents of a tighter monetary policy, while proponents of a looser stance warn of the risks of a recession, especially in the aftermath of the war in Ukraine.

More than 25 basis points?

Karsten Junius, chief economist of the Swiss bank Safra Sarasin, is betting, for example, on a 50 basis point rise in interest rates. In the current situation, according to Junius, the ECB should not focus so much on its announcements. For Traud, even if a central bank takes only a small step on interest rates initially, it is important that monetary regulators make it clear that they are ready to continue raising interest rates after September. And the same goes for their job, which is to keep inflation at 2%, so that the value of the euro remains stable.

However, the current situation is not easy for central banks. On the one hand, they need to normalize monetary policy. But if they brake too hard, they stifle the economy. “They can’t change anything in terms of energy prices anyway,” says Martin Lück, chief economist for Germany at Blackrock, the world’s largest asset manager, “so they should lower the price of other things, goods and services which way”.

Even without the intervention of the ECB, the risks of recession increase, especially if Russia does not reopen the gas tap next Thursday after maintenance work on the Nord Stream 1 gas pipeline. So, according to Lück, “normalizing” the policy monetary means approaching the “neutral interest rate”; that is, the interest rate at which the economy neither speeds up nor slows down. But it is still difficult to determine where this interest rate currently stands in the euro zone. And finally, the financial markets are also watching Italy. The government crisis is not making the situation any easier for the ECB. Prime Minister Mario Draghi remains in office, but it is unclear how long he will last.


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