All the economic headlines are being filled with questions about how central banks will act on interest rates. The question comes at a time of great uncertainty, super inflation and a Europe in need of rapid economic acceleration.
The interest rate policy decided from Frankfurt will condition our mortgages, our credit cards and even the type of product that banks will offer us throughout the year. In short, it will mark the year 2022.
But let’s take it one step at a time, why is a review of interest rate policy now so prominent and why can it affect our daily lives so much?
First of all, we have to talk about the extraordinary situation we are experiencing in Spain, where we are faced with a CPI that exceeded 6% last December.
During this year, we have witnessed an upward rally in the general price index that has been aggravated by the spectacular European1 aid package together with the rise in the price of Russian gas.
This widespread rise in prices has not only occurred in Spain, but in the Eurozone we are experiencing an all-time high of 5.1% (remember that the ECB’s goal is to keep inflation at 2%). This is causing all the alarm bells to ring and Lagarde is getting down to work.
In Spain we have not had these levels of inflation since 1992; neither the technological crisis, nor the entry into the euro, nor the beginnings of CoVid19 had left such high levels.
Now, it is clear that measures are needed to curb this inflation, but what can the ECB do to reverse this high rate:
- Maintain its negative interest rate policy and encourage financing. This is the situation we have been experiencing for several years: financing at 0 cost for the banks for subsequent transfer to end consumers. This policy favors end-user consumption, encouraging higher consumption and lower savings.
- Raise rates slightly in several hikes throughout the year. A situation that the FED has announced it will carry out during 2022. In this scenario, the interest rate is raised minimally with the aim of raising the cost of financing; this causes the consumer not to request so much credit (as it is more expensive) and therefore decides to grow on the savings side.
- Drastically raise interest rates. Unlikely situation in which the ECB would increase the cost of financing, harming indebted companies and favoring financial institutions. The end consumer would see how their liabilities would grow (mortgage, credits, etc.) and would be discouraged to consume, causing massive savings.
It should also be borne in mind that this situation is not something that is decided entirely freely by the ECB, but that Frankfurt will be closely monitoring what the other central banks (mainly London and New York) do.
If the Fed and the Bank of England decide to raise interest rates (already announced) and the ECB keeps them at 0, there will be a flight of safe-haven capital to these central banks, affecting the euro currency.
1 We talked about this possible consequence in the September Magazine: ‘Free money? No, thanks’ when we had inflation at 3%.
There are still many unknowns to be resolved and the situation in 2022 looks quite complex, but if you ask me how I want rates, I would say: American style and on point, Madame Lagarde!