The European Central Bank has ushered in a new era: it has raised rates for the first time in 11 years. And it has done twice as much as initially announced, half a point, 50 basic points, when the president of the entity, Christine Lagarde, spoke of 0.25 on June 9, after an emergency meeting. It is the biggest rate hike in 22 years by the ECB.
Europe tries to be on its guard against the crisis that is coming in the autumn
The ECB intends to puncture the inflation bubble, although inflation is not just a matter of excess demand, but of a context of war in Europe and an energy crisis. But the ECB seeks with its rise a regulation from another time: raising rates cuts consumption, hinders borrowing capacity, makes loans and mortgages more expensive and encourages savings. But that has little to do with the flow of energy from Gazprom, for example, or with a marginal energy market that, as the president of the European Commission, Ursula von der Leyen, herself acknowledges, has ceased to make sense.
“The decisions help us reduce inflation”, Lagarde said: “We will analyze the decisions meeting by meeting”. Lagarde has also defended the implementation of the TPI, the new instrument, “a shield that assures us that monetary policy is transmitted by all the countries of the euro zone. The TPI is a new tool that can be activated when there are threats to monetary policy. It will depend on the severity of the risks, purchases are not restricted in advance, and it will help the ECB in the price stability mandate”. Lagarde has highlighted that the approval of the TPI has been "unanimously" within the Governing Council, alluding to the reluctance announced by some of its hawk members: "All members of the euro zone can participate in the TPI, according to the criteria of eligibility and how the instrument is activated. The TPI is a program to face the risks of all the countries of the euro zone, and they are eligible based on certain criteria. If activated, the Governing Council will review the situation, and it will be at the discretion of the Governing Council.”
In this sense, Lagarde has said that the conditions of the new ECB anti-fragmentation tool include compliance with the milestones of the European recovery fund: "The instrument has been created in record time".
Thus, the Governing Council of the ECB has decided this Thursday to raise the entity's three official interest rates by 50 basis points. Consequently, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will increase to 0.50%, 0.75% and 0.00%, respectively, with effect from July 27, 2022.
“Indicators announce that energy prices will remain high, with inflation in June of 8.6%. Bottlenecks contribute to inflation”, said Lagarde: “We expect inflation to be this high for a while, but over time prices will tend to come down and bottlenecks to relax. The labor market remains vigorous, with low unemployment data”.
Regarding the risks, Lagarde affirms that “the prolongation of the war is a risk, which affects confidence, the supply chain and the economic slowdown. The risks of inflation remain high, and in the medium term it will affect the erosion of the economy. If demand falls in the medium term, it will relax prices."
"The decision will contribute to the return of inflation to the ECB's medium-term objective, strengthening the anchoring of inflation expectations and ensuring the adjustment of demand conditions for the achievement of its medium-term inflation objective", affirms the ECB : “The step to get out of negative interest rates agreed today [por este jueves] allows the Governing Council to transition to an approach where decisions on interest rates will be taken at each meeting. The future path of official interest rates agreed by the Governing Council will continue to depend on the data and will help it meet its inflation target of 2% in the medium term”.
“The materialization of inflation risks, the reinvestment of the PEPP and the creation of the TPI”, Lagarde said, “are what have led us to decide on a higher rate hike” than that previously announced: “We all reached the consensus of the 50 basis points. And in September? “Given the situation taken today, the following decisions will be made month by month and step by step. It will depend on the data we have in September and we are on a normalization path to reach the 2% path. We will decide month by month, meeting by meeting, based on the data. We are more flexible, and we will raise rates until the adjustment point is reached”.
“The cost of financing banks and individuals will increase, it is obvious”, continues Lagarde: “What we have to do is lower inflation to 2% in the medium term, it is time to comply: it has passed 8, 1% to 8.6% in the last month, to which is added the appreciation of the dollar against the euro, which is also related to inflation due to purchases of goods in dollars”.
TPI: new instrument to appease risk premiums
This Thursday the European Central Bank also specifies the instrument to clamp risk premiums in countries that need it announced at an emergency meeting a month ago in Frankfurt, a mechanism to respond to the pressure on the debt of countries like Italy, plunged also in a new political crisis. This new anti-fragmentation instrument must be able to spend more in some jurisdictions than in others –in Spain, Italy, France and Greece, for example–.
“The Governing Council has considered that the establishment of the Transmission Protection Instrument (TPI) is necessary to support the effective transmission of monetary policy. In particular, while the Governing Council continues to normalize monetary policy, the ICC will ensure the smooth transmission of the monetary policy stance to all countries in the euro area. The unity of the monetary policy of the Governing Council is an essential condition for the ECB to fulfill its mandate of maintaining price stability”, says the ECB.
The central bank adds: “The TPI will add to the toolkit and can be activated to counter unwanted or disorderly market dynamics that constitute a serious threat to the transmission of monetary policy in the euro area as a whole. The volume of purchases under the TPI will depend on the seriousness of the risks for the transmission of the policy. There are no ex ante restrictions on purchases. By safeguarding the transmission mechanism, the TPI will allow the Governing Council to more effectively fulfill its mandate to maintain price stability.”
“In any case”, says the ECB, “the flexibility in reinvesting the principal of the securities in the portfolio of the pandemic emergency purchase program (PEPP) that are maturing continues to be the first line of defense to counteract the risks to the transmission mechanism related to the pandemic”.
the bank wins
There are three countries in which a higher income for banks is expected with the rise in interest rates: Spain, Italy and Portugal. Southern Europe is the one that has been pointed out as the region in which its banks are going to benefit the most.
Moody's noted that Spanish banks, along with Italian and Portuguese banks, are expected to benefit more than those in northern Europe. The main reason that this analysis house points out is that these are markets where there is a large percentage of the mortgages granted that are at a variable rate and, therefore, they will have higher income for the banks with the rise in interest rates . For the rest of Europe, however, the effect will be "gradual and moderate."
Fitch, for its part, pointed out that among these three countries, it is the Spanish banks that are going to benefit the most from the change in interest rate policy. The agency justified this analysis by pointing out that, despite the fact that Spain will not recover the pre-pandemic level of GDP until next year, this course will lead the improvement of the economy, at least in southern Europe. This "provides better business opportunities for domestic banks," he said. Fitch also argued that the demand for mortgages is being resilient in the country. Added to this is the fact that Spanish banks arrive at this situation with significant cost savings, after the thousands of layoffs and closures last year, and will have a significant increase in income.