What hardly anyone would have thought possible has happened: the ECB is sending a clear signal in the fight against inflation. However, the sharp rise in interest rates has its side effects.
Before you get too excited: the ECB’s monetary policy is still relaxed despite the sharp interest rate hike of 0.5 percentage points. The key interest rate is now just 0.5 percent, the deposit rate is zero percent – and that with an inflation rate of over eight percent. In addition, the ECB continues to buy government bonds every month. So it does not pull money out of the financial markets, but continues to ensure high liquidity. A reduction in the balance sheet, as the US Federal Reserve has started, is out of the question.
But at least: the era of negative interest rates is over and the ECB is sending a clear signal. Hardly any observer had expected that they would actually decide to raise interest rates by 0.5 percentage points. It was in the room, but actually an increase of 0.25 percentage points was agreed. The ECB had so far reacted too hesitantly in view of the rising inflation rates to be expected to take such a step. Now the ECB is clearly showing that it is serious. Further interest rate hikes are to follow.
But the ECB’s renewed courage comes at a price. The future will show how high it is. Rising interest rates make it more expensive for countries like Italy to get fresh money. This could become a problem for such states in view of the already enormous mountains of debt. But the ECB is taking precautions here – and that is the second piece of news of the day. The central bank presented a new instrument, the “Transmission Protection Instrument” (TPI). It is intended to ensure that monetary policy works smoothly in all euro countries. The ECB sees this transmission at risk if the yields on government bonds, the so-called spread, diverge too far. The ECB pushed ahead with work on this new anti-crisis instrument after unrest on the financial markets in mid-June. After the first hints of an interest rate hike, they immediately made Italian government bonds significantly more expensive.
That shouldn’t happen again. “The TPI can be activated to counteract unwarranted disorderly market dynamics that pose a serious threat to the transmission of monetary policy in the euro area,” the ECB announced in its post-meeting statement. “The size of purchases under the TPI depends on the severity of the risks to monetary policy transmission. The purchases are not restricted from the outset.”
This means that the ECB has practically every opportunity to intervene in the financial market. It stretches a kind of safety net across all euro countries and caps interest rate increases. The incentives for a solid budgetary policy in the capitals of the euro states have fallen again. The ECB has defined some criteria that must be met before the program becomes active. However, the ECB reserves the last word. The disciplining effect of interest rates is de facto undermined and the ECB is placed even more at the service of state financing.
The good news is that, on the one hand, the TPI gives the ECB more leeway when it comes to rate hikes, because the negative impact on governments can be mitigated. The bad news is that the rules of the financial markets continue to be suspended. In extreme cases, the ECB can buy up unlimited amounts of government bonds. This increases the money supply – with likely negative consequences for the value of the euro. That would mean more inflation again.
