Europe Begins Fight Against Inflation, But We Can’t Expect a Fast Victory
Simona Striževska, Economist from Citadele subsidiary CBL Asset Management
This week, the European Central Bank (ECB) took a historic step, raising base rates in the monetary union for the first time since 2011. For several months now, the ECB has been laying the foundations for a rate raise. However, bearing in mind the record levels of inflation in the Eurozone, the ECB has decided to act more aggressively than planned, raising rates by half a percentage point and ending the negative rates experiment in the monetary union. It is already clear that rates will also be raised in September. However, bearing in mind the expected economic slowdown in the Eurozone, the ECB has stopped short of predicting how far it is willing to go.
How high will rates climb?
The market interest rates in the Eurozone, which are directly tied to decisions made by the ECB, began adapting to upcoming changes well in advance. The 6-month EURIBOR rate turned positive by the start of June, and is currently above 0.5%. The 3-month EURIBOR rate, which is usually lower than the 6-month, became positive a week ago. This means that, in the Eurozone in general, borrowing is gradually becoming more expensive both for new and existing borrowers whose loans include variable rates. Financial market participants expect the Eurozone’s upper limit to reach between 1.5 and 2.0% over the next few years, based on 3-month Euribor predictions.
Results depend on more than just the ECB
The ECB has the noble aim of slowing inflation rates in the Eurozone, but in the short term it will be difficult to notice a direct impact on inflation from this tightening in monetary policy. A certain period of time needs to pass before the effects of a stricter monetary policy on demand will be reflected in prices or at least slow their climb. Demand in Europe is not at risk of overheating as, for example, in the U.S.
The situation in the Eurozone is also complicated by the fact that, although price increases in the past few months have become wide-spread, two-thirds of consumer price increases in the monetary union are still concentrated in the energy and food sectors. These prices are dependent on the situation in the global commodity market, over which the ECB has no influence.
Can the ECB help fight inflation here and now? The answer is yes. First, unlike the U.S. Federal Reserve System (FRS), the ECB began raising rates almost six months later and plans raising them more gradually (the FRS predicts that interest rates, which are currently in the region of 1.50-1.75%, could climb to 3.75%), meaning the Euro has become significantly cheaper against the U.S. dollar over the course of this year. The cheap Euro then made resources even more expensive for Europeans, as these are usually traded in dollars. The ECB’s move beyond words could help strengthen the currency, thus reducing inflationary pressure.
Second, the message sent by central banks to investors, consumers and businesses tends to be much more important than their actions. The commitment of the larger central banks to fight price increases by aggressively raising interest rates, without being afraid to slow economic growth or even to flirt with recession, has led financial market participants and economists to significantly lower growth outlooks for Western countries for the next few years. With growing doubts about global demand, we have already witnessed certain cooling of commodity prices since the start of June.
The situation in the raw materials market could help dampen inflation
Since the beginning of the summer, the price of oil has gone down by almost 15%. The prices of agricultural products on the global financial markets went down by an average of 20%, while metal prices fell by 20-25% and are now below pre-war levels. If these trends continue, this should soon be reflected in inflation figures.
In the energy market, of course, there are also risks on the supply side, which can significantly change inflation, particularly in Europe. Despite this, it seems as though inflation in the U.S. and Eurozone could be close to its peak. As we approach the end of the year, pace of inflation should start to slow down organically due to the so-called base effects, as autumn last year is the time when prices began to rise more rapidly. This could, to a certain extent, make life easier for the central banks and reduce the need for further rate increases.
About CBL Asset Management
Citadele Bank’s subsidiary, IPAS CBL Asset Management, is one of the leading and most experienced financial asset management companies in the Baltics, employing globally-recognised fund managers. It has managed investment portfolios since 2002. Meanwhile, in 2003, it became one of the first in Latvia to manage level 2 pension savings. CBL Asset Management has the largest team of managers in Latvia, which regularly analyses the financial and capital market and macroeconomic trends using their experience and the latest technologies, investing pension savings in both large international and local Latvian businesses, as well as in the bonds of various countries.
Head of Corporate Communications
AS “Citadele banka”