On Thursday, the European Central Bank (ECB) announced its decision to raise its rates by 25 basis points in a bid to rein in inflation. The return on savings could now be a little higher, while borrowing could become a touch more expensive. It is the first rise in almost three years and makes the ECB the first major central bank to raise rates since the start of the US-Israeli war in Iran. In the uncertain geopolitical context, the ECB sees more risks of stronger price pressures than of a sharp drop in economic activity.
Speaking to RTL, Gaston Reinesch, Governor of the Luxembourg Central Bank (BCL) and a member of the ECB's Governing Council, first pointed to the very comfortable starting point at the beginning of the year. The deposit facility rate – the rate through which the Governing Council steers the monetary policy stance – was at 2% and inflation was also close to 2%, in line with the ECB's medium-term target. Then came the US-Israeli war in Iran at the end of February, the closure of the Strait of Hormuz and an ensuing energy crisis, with knock-on effects on energy-intensive products. According to the latest projections, inflation in the euro area could climb to 3.5% or more.
When taking decisions, the ECB weighs the impact of a rate rise on lending and on the wider economy, and according to Gaston Reinesch, the euro area remains in a "relatively acceptable situation". Growth projections currently stand at 0.8% for this year and 1.2% for next. Unemployment, meanwhile, sits at 6.3% in the euro area, which is a historically low level. Given the information available today, the Governor of the BCL said the decision to raise the key ECB interest rates had been "the logical and best one that could have been taken."
He also pointed out that the ECB's move had been anticipated by the markets and had largely been priced into market interest rates for several weeks already.
Reinesch was careful to add that, as anyone watching the news would know, something new could happen every day. The ECB has accordingly not set a fixed path for future decisions, although ECB President Christine Lagarde did sketch out possible scenarios on Thursday. In the worst case, where inflation significantly and persistently deviates from the 2% target, the response would need to be appropriately forceful. Even short of that, further adjustments could still prove necessary.
Reinesch said decisions would be taken meeting by meeting in light of incoming data, adding that in such an uncertain environment, one could not rule out that "not much more" would be necessary, nor that there might still be one or another rate rise by the end of the year.
Turning to euro area governments, the Luxembourg Central Bank chief said that any energy support measures now being taken in various countries that could also help to curb inflation could only be welcomed. For Reinesch, the picture is clear: inflation is bad for the economy and for people in the short and medium term, and especially harmful for those on lower incomes. On the subject of public debt, however, he was careful to add that he was not telling anyone to borrow more. Borrowing was possible, he said, but debt had to remain sustainable.
