The ECB raises rates by 0.75 points, the largest rise in history, in the face of inflation records

The biggest rate hike in history to try to deal with the highest inflation rates in history. The European Central Bank has approved this Thursday to raise rates 0.75 points, after the rise of half a point last July. That rise a month and a half ago was historic because it left behind 11 years of negative rates and undertook an unprecedented rise in 22 years. But this rise this Thursday pales that of July, as it represents the largest rise in the history of the ECB. “The Governing Council has adopted today's decision [por este jueves]and expects to raise interest rates again, because inflation remains excessively high and is likely to remain above target for an extended period”, says the bank chaired by Christine Lagarde.

The ECB raises interest rates 0.5 points, double what was announced, in the face of the price crisis

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Of course, the ECB's decision is a monetary response to one more price crisis that does not have so much to do with demand, but rather with supply hit by the energy crisis and the consequences of the war in Ukraine. Thus, the ECB's slowdown in consumption by way of rate hikes could affect economic growth, spurred on by the recovery funds, but also threatened by the geopolitical context.

In this sense, the bank itself acknowledges: “After experiencing a rebound in the first half of 2022, the latest data point to a substantial slowdown in growth in the euro area, and a stagnation of the economy is expected during the last months of the year. year and in the first quarter of 2023. Very high energy prices are reducing the purchasing power of citizens' income and, although the bottlenecks are relaxing, they continue to limit economic activity. On the other hand, the adverse geopolitical situation, especially Russia's unjustified aggression against Ukraine, is affecting business and consumer confidence. These prospects are reflected in the latest expert projections for the growth of the economy, which have been revised down notably for the rest of this year and for 2023. Experts now expect growth to be 3.1% in 2022, 0.9% in 2023 and 1.9% in 2024”.

The ECB has only made a move of this magnitude, of three quarter points, once. It was on December 10, 2008, but in the opposite direction: a decline in the midst of a financial crisis after the fall of Lehman Brothers.

The thesis is that monetary policy takes time to show up in inflation. Then? The questions that hang over Frankfurt are the following: What will come first? The brake on inflation or the brake on the economy? What the ECB does by raising rates, too, is to try to appreciate against the dollar, which can have an effect in the second round of lowering inflation due to purchases made in dollars: the more expensive the dollar, the more expensive costs the international market. The ECB is appreciating the euro, making the currency more expensive, so that it now costs more for citizens to ask for it when signing a loan or a mortgage. What's more, it directly affects credits and mortgages already signed, and that discourages consumption and the circulation of money... But, will inflation puncture before the economy cools down?

“The Governing Council has decided today [por este jueves] raise the three official interest rates of the ECB by 75 basis points", says the bank: "This important step anticipates the transition from the very accommodative level of current official interest rates to levels that will ensure the timely return of inflation to the target of 2% in the medium term of the ECB. On the basis of its current assessment, the Governing Council expects to raise interest rates at the next meetings to moderate demand and protect against the risk of a persistent increase in the inflation outlook. The Governing Council will periodically reassess its policy path in the light of new information and developments in the inflation outlook. Future Governing Council decisions on interest rates will continue to be data-driven and will follow an approach whereby decisions are made at each meeting."

The ECB recalls that, “according to Eurostat's advance estimate, inflation reached 9.1% in August. Strong rises in energy and food prices, demand pressures in some sectors due to the reopening of the economy, and supply bottlenecks continue to drive inflation. Price pressures have continued to intensify and spread throughout the economy, and inflation could continue to rise in the short term. As the current determinants of inflation fade over time and the normalization of monetary policy is transmitted to the economy and to pricing, inflation will decline. Looking ahead, ECB experts have revised their inflation projections significantly upwards and now expect it to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024”.

In short, “the persistent vulnerabilities caused by the pandemic continue to represent a risk for the smooth transmission of monetary policy”, says the ECB: “Therefore, the Governing Council will continue to flexibly reinvest the principal of the securities in the portfolio of emergency purchases against the pandemic that are expiring, with the aim of counteracting the risks for the transmission mechanism related to the pandemic.

Inflation difficult to control

In the ECB, moreover, the idea is beginning to spread that inflation will not be so easy to control. The scenario is new, and the data of 8.6% in June, followed by 8.9% in July and 9.1% in August, have been a negative surprise in the tower on the banks of the Main river. The European Commission itself expects to close 2022 with an inflation of 7.6% in the euro area, and 4% in 2023.

In other words, prices are going to remain very high at the beginning of 2023, with the current levels or higher in the coming months, and it will cost to be below 7%, which is already having a huge influence. For example? That the ECB decided in July to analyze and evaluate the situation month by month, meeting by meeting, to make decisions on rate hikes. Until now, there was a guide according to which monetary decisions were made from time to time at the meetings of the Governing Council, although indications were given on the future direction of monetary policy, known as forward guidance. But now it will be month to month.

Impact on mortgages

With this increase, a fifth of those mortgaged in Spain –exactly the 20% with the lowest income– will reach the red line of indebtedness, according to the sensitivity model that the Bank of Spain presented in the Congress of Deputies last June.

This "limit" that households should not exceed with respect to the payment of their debts is established at a financial burden of 35% of total income, according to different sources. The Bank of Spain itself points out that when it exceeds 40%, a "high effort" is being made, which entails the risk of delinquency, even non-payment. A still moderate threat compared to the economy as a whole, but worrying.

This increase in the cost of mortgages due to the rise in Euribor – the reference index for the interest rate or final APR – and the tightening of other loans are the nuts that the ECB is tightening with the increases in official rates. Its objective is to cool consumption, business investment or the spending capacity of states to combat runaway inflation. And the risk is that not only will price increases slow down, but the economy will go into recession.

In Spain, this danger is further away than in partners such as Germany or Italy due to the greater intensity of growth (in full rebound) at this time, due to tourism and due to the explosion of the service sector in general, finally without restrictions due to COVID.

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