Yesterday, the US Federal Reserve raised the key interest rate by 0.5 to 4.5 percent, today the ECB will follow with a step of the same amount to 2.5 percent. Although this had been expected in advance, the stock market fell significantly. Disillusionment prevails.
After two major increases of 0.75 percent, the European Central Bank (ECB) is also slowing down its interest rate turnaround. Today the monetary watchdogs announced the expected increase of 0.5 percent, which means that the key interest rate will then be 2.5 percent. They have now been increased four times in a row since the end of July.
The continued high level of inflation in the euro zone remains the reason for the renewed sharp rise in key interest rates. In October, it was 10.6 percent year-on-year. That was another 0.7 percent more than in September. There is a wide range: In the three Baltic states of Estonia, Latvia and Lithuania as well as in Hungary, prices climbed by more than 20 percent. At the other end are France, Spain and Malta with values between 7.1 and 7.4 percent.
Germany is listed in the EU statistics with 11.6 percent. This is slightly higher than the value of 10.4 percent reported by the Federal Statistical Office. The reason for this is that the EU uses a slightly different calculation system, which is harmonized across all member states and thus enables comparisons between countries.
The ECB is raising interest rates again in order to reduce high inflation. This works because the ECB can also control lending rates via the key interest rate. The higher the key interest rate, the more money banks get for sums that they simply park at the ECB. In order to issue loans instead, the banks charge interest rates above the base rate. In turn, higher interest rates mean that companies and private individuals borrow less money and therefore make fewer large investments – for example in real estate, machines, company takeovers or expensive cars. This generally reduces the demand for goods, which is why companies then have to lower their prices in order to still be able to sell goods and services.
However, raising interest rates is a fine line for central banks. In order to have the best effect on inflation, interest rates would have to be higher than the rate of inflation. For that, however, the ECB would have to more than quadruple the current rate. However, such a strong increase would probably bring the demand for credit to a standstill overnight. Without credit, however, there is no investment and the economy would therefore lose strength – a recession would be the result.
In the US, the Fed has already announced that it intends to take this risk in order to dampen inflation. Accordingly, the interest rate there, at 4.5 percent, is already significantly higher than in Europe. And Fed Chair Jerome Powell has announced that he will continue next year, albeit in smaller steps. In the end, interest rates could be more than 5 percent. The aggressive policy is already having an effect: in November, the US inflation rate fell to 7.1 percent, the lowest level of the year.
The ECB has announced no further hikes today. In contrast, the decision to raise interest rates states: “The key interest rate decisions of the Governing Council of the ECB will continue to depend on the data available and will be determined from meeting to meeting.” In other words: If inflation does not fall, interest rates will be raised further.
This has an impact on the German financial and economic situation. As a result of the key interest rates, construction and real estate interest rates have also risen significantly this year. According to an evaluation by the savings banks, they have quadrupled from an average of 1.0 to 4.0 percent. Despite possible further interest rate hikes, this should come to an end next year. “In 2023, construction interest rates will in all likelihood not rise as much as in 2022,” says Mirjam Mohr, Interhyp board member for private customer business. However, moderate increases are still possible. A pleasant side effect: On the other hand, real estate prices have already fallen slightly on average this year.
Interest rate increases are also a bad sign for the stock market, which is why the Dax collapsed by 2.5 percent after the US interest rate hike yesterday and spontaneously slipped another 0.6 percent after the ECB decision today. There are two reasons for this: First, every time interest rates rise, other forms of investment become more attractive, such as call money and bonds, whose interest rates also rise. Second, as mentioned, interest rate hikes are crippling the economy. If companies grow more slowly – or not at all – their shares are also worth less, so investors sell them and prices fall.
The ECB could shake up the bond market next in 2023. It still holds around 5 trillion euros from the various bond purchase programs of the low-interest phase and the Corona crisis. It should be gradually dismantled from spring onwards. That would then have the opposite effect to the purchase programs: the more bonds the ECB offers, the lower the price for a single bond. In order for buyers to get their money’s worth, interest rates would rise in return. This also applies to those who have to bid states for new government bonds in order to compete with the ECB’s holdings. As a result, interest rates on bonds are likely to rise even further in 2023. This is becoming a particular burden for highly indebted countries such as Greece and Italy.
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However, these states would probably forgive the ECB quickly if inflation fell as a result of the measures. However, this may still take a while. Although Germany recently reported a slightly falling inflation rate, it is still in the double-digit range. Accordingly, interest rates will also stay up. “You still have to go a long way further,” says Ulrich Kater, chief economist at DeKa Bank. Reductions can only be considered again when the inflation rate falls to two percent. According to economists, this will not happen until 2024 at the earliest.
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