Market: Why are central banks raising interest rates to curb inflation?

(BFM Bourse) – In response to rising inflation, several central banks have raised their interest rates in recent months. The ECB recently raised its tone by proceeding for the first time since 2011, to a more marked increase in its rates to combat record inflation in June. Why this almost universal movement?

The ECB this week joined the race to raise rates in which many other central banks of the world are already participating, with an increase of 0.5 points, the first since eleven years and stronger than expected . Why is the acceleration of the rate increase? Due to the increase in inflation: + 8.6% in the euro zone in June, + 9.4% in the United Kingdom, + 9.1% in the United States, and sometimes even double figures in developing countries, such as Brazil.

The ECB’s decision is more symbolic

Almost everyone is worried: according to the International Monetary Fund (IMF) 75% of the central banks monitored have raised their rates in the last 12 months. The US Federal Reserve (Fed) has revised its rates up three times since January, from 0.25% to 1.75%, while the Bank of England (BoE) has chained five increases since the middle of December, from 0% to 1.25. %. “There is a kind of panic linked to the increase in inflation”, explained Gregory Claeys, economist at the Brussels Bruegel Institute.

“They must act quickly and visibly act to prevent inflation expectations from becoming strong, i.e. people who expect more inflation” that leads to an increase in prices and wages, added Paola Subacchi, professor of international economics at Queen Mary University of London.

Compared to other central banks, the ECB’s decision on Thursday is more symbolic, as it has already closed the page on negative rates. As for the Bank of Japan, it stands with rates close to zero, even negative in the face of inflation of “only” 2.3%, close to its objectives. A decision that was criticized in a country that is more used to freeze prices since the end of the 1990s.

What are the expected effects of the rate hike?

Rate increases aim to prevent an overheated economy by restricting access to credit for households and businesses. For Europe, this policy takes “an average of 18 months depending on the model”, says Gregory Claeys. Effective in slowing down demand, it is not so much against external shocks (energy, food) that are currently exacerbating inflation in the continent, he warned.

This is the limit of monetary policy and the reason why major international organizations such as the IMF and OECD call on States at the same time to provide temporary and targeted aid to populations hit by rising prices.

Have central banks waited too long?

Major central banks have long argued that inflation is cyclical, linked to the economy’s rapid recovery from the pandemic. But waiting increases the risk of prolonged inflation, especially by triggering the dreaded price-wage loop. “The ECB may have waited longer than others because of its desire to put its tools in the fight against fragmentation”, aiming to protect the weakest countries in the euro zone against speculative attacks. – attack, justified Martin Wolburg, economist at Generali Investment.

The absence of a coordinated response is also linked to parameters specific to each zone: the United Kingdom struggling with the effects of Brexit, the United States facing a real lack of jobs, and the euro zone where “inflation is inherently less worrying than the United States”, because it is linked to a supply shock, estimates Amaury Goguel, associate professor at the Skema business school in Lille.

A recession in sight?

By raising interest rates too much, central banks also risk slowing the economy too much, leading it into recession. If it expects a “sad” economic outlook for the EU, the ECB is thinking of avoiding recession in 2022 and 2023. Most optimistic according to Mr. Wolburg, for whom the euro zone may be “on the verge of recession in the second half” .

n more risk if the US falls into it, which will drag the global economy in its recovery. However, “the signs there are not catastrophic at the moment”, insists Amaury Goguel, “production, consumption and the labor market remain positive although the latter remains very tense. But if a recession occurs, the The ripple effect can be real.”

The wait-and-see behavior of the ECB however also brought the euro to parity against the dollar, which improved the competitiveness of exporting companies, “and the first quarterly results (of European companies) underline this” , recalled Mr. Google.

(With AFP)

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