The European Central Bank on Thursday unveiled a daring move to increase its benchmark interest rate by 0.5 percentage points in an effort to rein in inflation.
The ECB raised rates for the first time since 2011 and returned the main interest rate in Europe to zero. Since 2014, the region’s rates have been declining.
The decision will become effective on July 27 as Europe fights record inflation fueled by rising energy prices. In the European Union, annual inflation spiked to 9.6 percent in June. For the 19 nations that use the euro, it was 8.6%.
Based on a “new assessment of inflation risk,” the central bank determined it needed to be more active than it had previously suggested it would be. In order to maintain its flexibility, the central bank chose not to commit to a certain trajectory for rate increases in the future.
In order to keep borrowing prices in the eurozone’s heavily indebted nations like Italy and Greece under control, the ECB today introduced a new bond-purchasing instrument. The central bank uses the region’s unified currency to maintain cohesion.
The so-called Transmission Protection Instrument, according to the central bank, “may be engaged to prevent unjustified, disorderly market dynamics that constitute a substantial threat to the transmission of monetary policy across the euro area.”
Lagarde highlighted that the European Central Bank is prepared to use the tool if necessary, provided that countries meet specific criteria for economic and budgetary soundness.
European Central Banks takes a calculative risk
The statement was met with a muted response from investors. Following the revelation, the euro, which just reached parity with the US dollar for the first time in 20 years, rose to roughly $1.02. The Stoxx 600 index was unchanged as European markets battled to find direction.
Because European businesses must pay more for imports, notably energy, the problem of inflation is being made worse by the currency’s weakening.
The ECB confronts a difficult road ahead in its increased attempts to halt the sharp rise in prices. The European economy is still supported by the summer tourist season, savings from the pandemic, and a healthy labor market, but growth is decreasing.
The central bank has not yet scheduled a recession. On the contrary, it predicted in June that output would increase by 2.8 percent this year and by 2.1 percent in 2023.
The ECB already lags considerably behind its competitors. After lowering rates to zero at the start of the pandemic, the Fed has been raising rates nonstop since March in an effort to rein in inflation that has been out of control. The only institution that hasn’t changed is the Bank of Japan, which kept up its ultra-easy policies on Thursday.
It also has to cope with a lot of uncertainty in the energy sector, which makes predicting future inflation challenging.
Thursday saw the important Nord Stream 1 pipeline’s gas supplies resume, allaying concerns that it wouldn’t reopen after a planned maintenance period. However, the concern that Russia would still cut off the gas at some time in response to Western sanctions persists despite the fact that it isn’t running at full capacity.
A political crisis that is roiling the nation’s financial markets is gripping Europe’s third-largest economy. An investor favorite, Italian Prime Minister Mario Draghi, offered his resignation to the president on Thursday after losing the backing of a number of significant parties in his ruling coalition. Early elections can result from such.
