Historical: The ECB raises the key interest rate sharply - and now expects 8.1 percent inflation in the euro zone

Created: 09/09/2022 05:29

By: Thomas Schmidtutz

ECB headquarters in Frankfurt: The currency watchdogs expect inflation rates to rise further and are raising the key interest rate significantly.

© Andreas Arnold/dpa

In the fight against record-high inflation, the ECB is now taking action - and raising the key interest rate more than ever before in the history of the euro zone.

Frankfurt/Main - The European Central Bank (ECB) is fighting record inflation in the euro area with a historic interest rate hike.

For the first time in the history of the central bank, the ECB Council decided to raise interest rates by 0.75 percentage points.

This increases the key interest rate at which commercial banks can borrow fresh money from the ECB to 1.25 percent, as the central bank announced on Thursday in Frankfurt.

At the same time, the ECB held out the prospect of further interest rate hikes in the coming months.

The Governing Council of the ECB had already signaled a further interest rate hike of 0.5 percentage points for its September meeting.

However, the ECB now expects inflation rates to continue to rise.

After that, inflation in the current year should be 8.1 percent, it said on Tuesday.

In June, the monetary watchdogs had still assumed a value of 6.8 percent.

End of interest rate policy: no more penalty interest for savers

After much hesitation, the Governing Council of the ECB raised interest rates in the euro area for the first time in eleven years at its meeting on July 21.

To the delight of millions of savers, the central bank ended the phase of the negative interest rate policy: since then, commercial banks no longer have to pay 0.5 percent interest when they park money with the central bank.

Many banks took this as an opportunity to abolish so-called custody fees for their customers.

The so-called deposit rate rises to 0.75 percent after the ECB decision on Thursday.

The ECB had long interpreted the high inflation as temporary and initiated the turnaround in interest rates much later than many other central banks.

The US Federal Reserve, for example, has already raised its key interest rate several times, twice by 0.75 percentage points each time.

The three key interest rates of the European Central Bank

The most important goal of the European Central Bank (ECB) is the stability of the common currency.

The target is an inflation rate of two percent.

The most important adjustment screws in monetary policy are the three key interest rates of the ECB, which were increased on Thursday for the second time in a few months due to persistently high inflation.

An overview:

How do the different interest rates work?

ECB interest rates are the central bank's main tool for controlling the money supply in the Eurosystem.

This is done by the central banks using the various key interest rates to set the costs that commercial banks in the euro area incur if they want to borrow money from the ECB or deposit it there.

When interest rates are low, banks can lend money cheaply - loans for private consumers and companies then become cheaper, and the amount of money in circulation increases.

Conversely, higher key interest rates lead to higher borrowing costs and thus indirectly to a decrease in the money supply.

main refinancing rate

The main refinancing rate of the ECB is the most important key interest rate.

This determines the interest rate at which banks can borrow money from the central bank.

The minimum term here is one week.

The following applies: If the interest rate rises, the costs for the banks and thus for the consumers also increase in the form of higher interest rates on personal loans.

Conversely, a low main refinancing rate ensures cheap money and thus cheap credit.

The main refinancing rate was zero percent from March 2016 until this July, then rose to 0.5 percent and now to 1.25 percent.

top lending rate

The top lending rate determines the cost at which commercial banks can borrow money from the ECB in the short term.

Although banks can also lend money to each other in the short term, these loans must inevitably have a lower interest rate than the ECB's top refinancing rate, since otherwise the lending business between banks would not be worthwhile compared to borrowing from the ECB.

In effect, the prime lending rate represents an upper interest rate limit for overnight money. It was raised from 0.25 to 0.75 percent in July, and now to 1.5 percent.

deposit rate

The deposit rate determines the interest rate at which banks can deposit excess money with the ECB.

Similar to the top lending rate, banks can also invest money among themselves in the short term.

However, since no bank will accept a lower interest rate than the ECB's deposit rate, this key interest rate is de facto a lower interest rate limit for overnight money.

In June 2014, the ECB lowered the deposit rate into negative territory for the first time, to minus 0.1 percent.

Banks then had to pay money if they wanted to deposit liquidity with the ECB.

In September 2019, the deposit rate was lowered to minus 0.5 percent.

From July it was zero percent, from Thursday it was plus 0.75 percent.

There is no end in sight to the rise in prices

There is no end in sight to the price increases in the euro zone: In August, inflation in the currency zone of the 19 countries climbed to a record high of 9.1 percent, driven by rising energy and food prices.

Economists expect a further increase in the coming months.

In the medium term, the ECB is aiming for a stable price level with annual inflation of two percent for the common currency area.

The high inflation is becoming an enormous burden for more and more people, Bundesbank President Joachim Nagel said recently.

Nagel, who has a say in monetary policy in the ECB Council, spoke out in favor of a “major interest rate hike” in September and explained: “Further interest rate hikes can be expected in the coming months.” Monetary policy must be resolute in combating high inflation.

ECB: concerns about the economy

At the same time, monetary authorities are concerned that the economy, which is already having to do with supply bottlenecks and the consequences of the Ukraine war, for example on the energy market, will be slowed down by normalizing the monetary policy, which had been ultra-loose for years, too quickly.

The ECB therefore reserves the right to help heavily indebted euro countries by buying bonds.