13th Aug 2022

ECB exits negative rates, amid fears of a new eurocrisis

  • ECB president Christine Lagarde said on Thursday that negative interest rates will end by September (Photo: Consillium)
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At a press conference in Amsterdam on Thursday (9 June), European Central Bank president Christine Lagarde announced the bank's governing council had "unanimously" decided to stop buying government debt and end negative interest rates by September — two of the main tools monetary authorities use to control prices and liquidity.

Inflation in Europe has reached 8.1 percent, and the bank was under increasing pressure to act.

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The bank deposit rate currently sits at -0.5 precent, and will now move to -0.25 percent on 21 June when the bank's governing council is next scheduled to meet.

Some of the bank's more hawkish council members in recent months increasingly called for higher interest rates, including Dutch central banker Klaas Knot, who stood next to Lagarde on Thursday.

These bankers expect higher rates will dampen inflation.

Increasing rates will increase borrowing costs for companies, households and governments.

This means demand for products and services will drop across the board, pushing down wages and eventually leading to higher unemployment, lower demand and lower prices.

But former ECB president Mario Draghi told Bloomberg on Thursday that inflation in Europe is not caused by excess demand.

Lagarde also said the move will not limit inflation in the short run. 75 percent of the price increase is "imported," she told press.

Inflation is mostly caused by high energy and food prices, and is also pushed up by Chinese Covid lockdowns — things Lagarde has said in the past European monetary authority has little influence over.

Immediately after government borrowing costs shot up, particularly for Italy where rates on 10-year bonds went up 0.3 percentage points to 3.7 percent, nearly three times as high as in early February.

This led some, including Robin Brooks, chief economist for the Institute for International Finance, a Washington-based trade group, to fear a new recession is about to start.

The last time the ECB raised interest rates in 2011, it caused a European debt crisis resulting in highly-indebted member countries — notably Italy and Greece — paying double-digit rates on government loans, which nearly collapsed the union.

No fundamental reform of the European economy has taken place since, and the problems that existed then, still exist today.

"If rates were to rise sharply for longer, we might well be facing Euro Crisis 2.0," Deutsche Bank investment strategist Maximilian Uleer recently warned.

When Lagarde was asked what tools the ECB has to prevent this from happening again, she signalled the €1.7 trillion pandemic emergency purchase programme (PEPP) could be used to refinance debt from weaker economies.

Lagarde said in a blog last month: "If necessary, we can design and deploy new instruments" to counter borrowing costs for member states, such as Italy, spiralling out of control, but when pressed on Thursday she did not give any details, a decision that was criticised by some.

"Better have a clear strategy in place before spreads get out of control," ECB-watcher Frederic Ducrozet, head of macroeconomic research at Pictet Wealth Management, a Brussels-based financial institution, tweeted on Friday.

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