Sluggish eurozone economies will not welcome ECB’s interest rate rise
Interest rates went up again across the eurozone on Thursday – probably for the last time during this cycle of hikes that has become a familiar story in the single currency bloc, as it has in the UK and US.
The European Central Bank (ECB) raised its main deposit rate by a quarter of one per cent to 4% – the highest level in the euro’s history.
With most economies across the 20member currency area suffering a dramatic slowdown in private sector activity, the increase in borrowing costs will be unwelcome.
Germany, the industrial heart of the EU, fell into recession this year, while France and Italy are close to stagnation with growth rates only marginally above zero.
Analysts at the Kiel Institute said the main reasons for the expected 0.5% contraction this year in German GDP (gross domestic product) were “weak industrial activity, the crisis in the construction sector and weak consumer spending”.
German companies expect the march back to growth will be long and arduous.
Consumers in the EU’s largest economy, circumspect about the future, are holding back on major purchases and saving furiously to shore up their personal finances.
French households are also putting more aside in their savings, prompting the European Commission to say it expects France to grow by just 1% this year and 1.2% next. Italy’s GDP growth rate will be weaker at 0.9% this year and 0.8% next.
Spain, on the other hand, is credited with supporting household spending power after an aggressive stance on local inflationary pressures – in particular, capping energy price rises – and for its efforts will be rewarded with growth rates of 2.2% this year and 1.9% in 2024.
However, the ECB tracks the average for the entire zone and is concerned that a weak recovery will go hand in hand with higher than expected inflation.
The inflation rate this year will be 5.6%and 3.2% next year, before falling further towards the 2% target in 2025, when it is due to hit 2.1%.
The ECB president, Christine Lagarde, hinted that 4% was the expected peak in interest rates, and international investors are betting the same. What is more in doubt is the duration. Lagarde has given a strong indication that the current 4% rate will be in place during 2024.
A material deterioration in the outlook could force the ECB’s governing council to cut earlier, but there would need to be a slowdown in economic activity that increased unemployment, cut the vacancy rate, reduced wage demands and triggered company bankruptcies.
That is a good deal to go wrong. More likely is a year of stagnation accompanied by above-target inflation and historically high interest rates.