ECB Interest Rate Hike For the First Time in More Than 11 Years
Owing to the soaring inflation, the European Central Bank (ECB) announced to increase its key interest rate by 0.5 percentage points to 0.0% on July 21 and planned further hikes this year, far exceeding the market expectation. It was the first benchmark rate hike by ECB in more than 11 years. According to CNBC, “the Frankfurt, Germany, institution had kept rates at historic lows, in negative territory since 2014, as it dealt with the region’s sovereign debt crisis and the coronavirus pandemic.” However, the data from Eurostat demonstrated that the annual inflation reached a record high of 8.9% in July 2022, up from 8.6% in June 2022, far above the bank’s 2% target, which was mainly driven by the surge in food and energy prices. According to BBC, “The euro zone is vulnerable because it relies heavily on Russia for its oil and gas. This week it urged member states to begin rationing supplies amid fears Moscow will halt gas deliveries this year, causing further price spikes.”
ECB released an anti-fragmentation tool—TPI (Transmission Protection Instrument), in order to weigh the fundamentals and prospects of the economies of all member states in the euro zone and to ensure that “the monetary policy stance is transmitted smoothly across all euro area countries”. In consequence of the various levels of public debt, the interest rate hike might have diverged effects in euro member states. For instance, investors are inclined to favor safer government bonds from countries that have financial stability, instead of those from highly indebted countries. The new tool is aimed at “supporting those nations with lofty debt piles and high borrowing costs, like Italy,” through purchasing government bonds of certain countries that have experienced rising borrowing costs “deemed not to be their faults”, with the main proviso that they would comply by EU’s fiscal framework and stick to “sound and sustainable macroeconomic policies.” More demands for government bonds from highly indebted countries drive the price, reduce yields, therefore, cut down their financing costs, prevent them from falling into the vicious debt spiral, and avoid the latent recurrence of the European debt crisis.
However, aided by TPI, will the hike save Europe that has bogged down in both geopolitical conflicts and severe weather? Some experts believe that the euro decline should attribute to two factors: the uncertain trend of the geopolitical conflicts and the adverse balance of trade. The increasing prices for energy, food and oil significantly lift importing costs; meanwhile, exports subjected to sanctions against Russia also plunged, which caused the trade deficit. According to Destatis, Germany’s exports in May were still 11.7% higher than the same month a year earlier, though 0.5% lower from the previous month. However, the imports bill went up by 27.8% from a year ago and rose 2.7% on the previous month, reaching 126.7 billion euros, which triggered a trade deficit of 1.0 billion euros, the first trade gap since 1991. Data from Trading Economics noted that the euro area recorded a trade deficit of 24.6 billion euros in June this year, marking the eighth consecutive gap, above market estimates of a 20 billion euros deficit and swinging from a surplus of 17.3 billion euros in the corresponding month of the previous year.
Furthermore, the Fed’s contractionary monetary policy is dragging euro. Li Gang, research director of China Foreign Exchange Investment Research Institute, pointed out that the ECB’s lagging contractionary monetary policy compared with the Fed is putting euro in a volatile and weak situation, confronted with the strong dollar. According to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Aug 19, speculators’net long positioning on the US dollar climbed by $0.4 billion from the previous week, reaching $13.37 billion, which was the first increase in four weeks. In contrast, euro net shorts jumped to 42,784 contracts, the largest since February 2020.
Though euro remains bearish, it is still unknown whether TPI will effectively avert further fragmentation, and whether the ending of the Ukraine War will help reverse euro decline.
