ECB raises its rates and commits to do more in the next meetings
Wednesday 14 September 2022
September 2022 | 2 minute read
Until not so long ago, monetary policy used to be a subject interesting only for a few experts and financial market participants, looking at subtle nuances of the central bankers, trying to decipher signals related to future decisions.
The Covid-19 pandemic, a substantial increase in inflation due to supply-chain bottlenecks and geopolitical tensions have contributed to a substantial shift in both monetary and fiscal policy.
As a result, central banks are under the spotlight, especially in the developed markets. On Thursday, 8 September 2022, the Governing Council of the European Central Bank decided to hike the key policy rates by 75 basis points1. This is the highest level of the rates since 2011, and follows a 50 basis point increase of 27 July 20222.
During the press conference that follows the monetary policy meetings, ECB’s president, Christine Lagarde, explained that the decision was taken unanimously by the members of the Governing Council to try to tame an inflation that persistently overshoots the ECB’s target3.
The ECB’s primary goal is to keep prices stable and therefore inflation under control. The ECB has a clear inflation target of 2% and it is important for a multitude of reasons: a low level of inflation means that private citizens can plan their savings and spending easily, knowing that the purchasing power of their money is not going to change substantially from one year to another.
In addition to that, targeting an inflation of 2% provides a safety margin against the potential risks of deflation and allows room for differences in inflation rates across the Eurozone countries.
Why is the ECB so keen to keep inflation under control? An increase of prices, in practice, means that we can afford less goods and services with the same quantity of money. In particular, goods that we all need like energy and food, tend to have prices that are more “sensitive” and therefore tend to have more pronounced increases in a shorter period of time. This has a negative effect in particular for the most vulnerable parts of our societies.
We are now facing a serious situation in the Eurozone. The ECB staff has updated their projections, and inflation is now expected to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 20243. Inflation is driven by the increase of energy and food prices, strong demand of services and persistent supply-chain bottlenecks. Inflation may continue to rise in the short term.
Economic growth will also slow down. The new projections have been revised down for this year and the next. The ECB now expects the Eurozone economy to grow by 3.1% in 2022, 0.9% in 2023 and 1.9% in 20243, and this year’s decrease is due to inflation dampening spending and production, weakening global demand and high uncertainty.
To deal with this complex situation and try to reduce inflation, it is reasonable to expect that the ECB will continue to increase its rates, keeping its hawkish stance in the coming months, as Lagarde mentioned that hikes should be expected at the next “several meetings”. When asked about how many “several” means, Lagarde mentioned that “it's probably more than two, including this one, but it's probably also going to be less than five”3.
"“There was a time, not too long ago, when central banking was considered to be a rather boring and unexciting occupation. […] Some thought that monetary policy could effectively be placed on auto-pilot. I can confidently say that this time has passed”
Former President of the European Central Bank, Mario Draghi
When asked about where the neutral rate is for the ECB, President Lagarde provided little indication, and that the ECB will maintain a meeting-by-meeting, data dependent approach.
“There was a time, not too long ago, when central banking was considered to be a rather boring and unexciting occupation. […] Some thought that monetary policy could effectively be placed on auto-pilot. I can confidently say that this time has passed”, said the then-President of the European Central Bank, Mario Draghi, in 2013. His sentence was related to the financial crisis of 2011, but even if years have passed, it still remains true today.
1. Source: European Central Bank, Monetary policy decisions, 8 September 2022
2. Source: European Central Bank, Monetary policy decisions, 27 July 2022
3. Source: European Central Bank, Press conference, 8 September 2022
4. Speech by Mario Draghi, President of the ECB, at the “Room for discussion” of the Study Association SEFA and the Faculty of Economics and Business, Amsterdam,15 April 2013.