The management of the European Central Bank (ECB) at its monetary policy meeting on 8 September decided to raise euro interest rates by 75 basis points. The response to a new record level of annual inflation in the euro area in August (provisionally 9.1%) is the largest rate hike since the creation of the ECB and the introduction of the euro.
Up until now, the record for a one-time rate hike in the eurozone was 50 points, and that hike has been experienced three times so far, in April 1999 and June 2000, and July this year (the most popular step up has historically been 25 points, experienced 16 times). The ECB does not stop raising the interest rates of the euro with this step. Keep on.
The latest ECB forecasts on GDP and inflation were also published at the September meeting (Figure 4). Energy price developments and supply challenges, especially in Europe, price pressures in the services sector following the opening of the economy after the pandemic, wage growth and the depreciation of the euro have led the revision of inflation forecasts significantly upwards (to 8.1% this year).
Thanks to the positive surprises of the economic data of the first half of the year, the ECB raised the GDP indicator forecast for this year to +3.1%, but due to the challenges in the supply of energy resources, the high inflation and worsening consumer sentiment, the GDP forecast for 2023 has been lowered to +0.9%. According to the ECB, a recession next year is expected only in the worst case scenario, if there are problems with the supply of energy resources combined with a cold winter.
Conclusions for loans:
Here, too, the question is appropriate whether raising rates is bitter medicine against inflation, because there is bitterness in paying interest on loans, but no reduction in inflation is promised in the foreseeable future. But one thing is clear, credit costs as low as in the previous eight years, we will not experience in the next few years (if we ever do). The ECB is on the road to raising interest rates, which it has no intention of exiting yet.
As for further interest rate hikes, the head of the ECB did not provide more precise information at the press conference, only promising hikes in the next one to four meetings (this answer was “extracted” by the head of the ECB at the press conference from journalists) and decisions will be made on the basis of current data. The next ECB meeting is on 27 October and another interest rate hike looks all but guaranteed, meaning further increases in loan interest costs, but the pace of cost hikes may also moderate. Since most previous predictions about the future of interest rates can be thrown away, there is little point in trying to guess again exactly how much the cost of borrowing will rise.
As a consolation, it can be said that from the prices visible on the market, it seems that the market is currently signaling the 3-month Euribor rate to move towards 2.5% (on September 8, the 3-month Euribor rate was 0.836 % ), which is a level lower than, for example, the expected increase in US dollar interest rates. You also have to take into account that market signals have never been accurate until now, because no one really expected rates to go above 1.5% in the spring.
To date, the 0.836% appreciation forecast for the 3-month Euribor rate is approximately another 1.6%, and for a loan of 100,000 euros, the interest payment would increase by approximately 1,622 euros (~135 euros per month) if the principal amount is not repaid. However, since in Latvia the repayment of the loan principal also constitutes a significant part of the monthly payments, the forecast of the increase in interest costs in euro terms is lower. These are numbers that could approach the increase already experienced so far. But because the terms of the loans and the interest rates charged are so different, the results are also different for each borrower.
Some other conclusions:
The market has positive euro interest rates, which will revive the long-forgotten deposit market. Similarly, negative interest rates were not implemented immediately and not at all, even with positive interest rates in the field, it will be some time before they start to significantly affect the market.
Deteriorating sentiment indices, high inflation and rising interest rates add to the risk. Since the price of money conditionally has two components – the cost price and the risk price, the “acceleration” of the cost of new loans is also possible on the market, since both of the above components are growing.
While growth in household deposits has slowed in recent months, it’s still growth and means the economy can survive a combination of inflation and rising interest rates. Latvia’s biggest challenge is not the upcoming winter, which can be overcome mathematically, but the growing gap between high- and low-income families that has grown in recent years. The ECB also recognizes the need for targeted support for those hardest hit by record inflation.
Although the bitterness can already be felt, it is hoped that the ECB’s “medicine” will successfully cope with the reduction in the inflation rate, because high inflation is an undesirable “disease”. Unfortunately, raising interest rates (and also regulating the quantity of money) are the only “medicines” that the ECB can give, but the ECB has no power over the vicissitudes of the energy market.
