Whatever is needed. With these three words, the then head of the European Central Bank removed doubts in July 2012 about whether the euro had a future. Mario Draghi’s message to the financial markets was that they should not doubt their commitment to defending the single currency. The warning worked.
Ten years later, the ECB is back in the spotlight, but so are two other major central banks: the US Federal Reserve and the Bank of England. All three face the same problem: what to do in the face of annual inflation rates that are rising to 10%.
Thursday marks the start of a crucial month in which the ECB will raise interest rates for the first time in 11 years. With a clear symmetry, Draghi returns to play a key role, this time threatening to resign as Prime Minister of Italy.
The prospect of the ECB tightening its position had already alarmed markets even before a political crisis loomed in the eurozone’s third largest economy. Investors demanded a higher premium to finance Italy’s huge national debt, so in response to the events of 2012, the yield (or interest rate) on Italian bonds has risen. The gap – or spread – can be expected to widen further compared to German bond yields if Draghi resigns.
This creates a dilemma for the ECB. On the one hand, it is committed to tackling inflation but on the other it wants to minimize the impact in Italy. “No matter if Italy goes into crisis or not, the ECB will have to raise rates this week and say it will do more if necessary in the next meetings,” said Ipek Ozkardeskaya of Swissquote Bank.
Christine Lagarde, Draghi’s successor as ECB president, said her team would propose a new instrument to protect Italy from any adverse impact of higher rates, and financial markets expect it to do so this week.
“Ten years after Draghi’s promise to do whatever it takes, Christine Lagarde runs the risk of repeating history,” said Neil Shearing, chief economist at Capital Economics. “He must avoid falling into another crisis that would ultimately require him to make a promise similar to his predecessor.”
The weakness of the euro against the US dollar is an added complication, and one of the reasons the single currency falls below parity for the first time in two decades earlier this month is that rates US interest rates are already between 1.5% and 1.75% while those of the ECB’s main interest rate is zero.
So after this week’s decision in Frankfurt, attention will shift to Washington DC. While the ECB’s decision comes down to whether interest rates should rise by 0.25 or 0.5 percentage points, the Fed is considering whether to adjust it by 0.75, or even one percentage point. complete.
Until the release of the latest U.S. cost of living data, the hypothesis on Wall Street was that Fed Chairman Jerome Powell and his colleagues would repeat the June 0.75 point increase. However, last week’s news that inflation had risen to a 40-year high of 9.1% unsettled investors as it sparked fears of a tougher response.
Krishna Guha, of Evercore, the investment banking advisory firm, said the indications were that the Fed would opt for a less than 0.75 increase.
“This is still a big move and we expect the Fed to be decidedly astute in terms of the rate trajectory [the future course of borrowing costs]but adhering to a more consistent sequence of heights reduces the risk of the Fed outperforming badly, that is, raising rates much more than is ultimately necessary to control inflation. “
The same complicated balance – preventing inflation from rising and at the same time avoiding sending the economy into recession – is causing headaches for the Bank of England, which will be the last of the three central banks to announce its policy decision.
The Threadneedle Street Monetary Policy Committee (MPC) has raised interest rates at its last five meetings. They currently stand at 1.25%. The City Council sees a sixth increase as a nailed certainty for early August, with divided opinions on whether the Bank opts for a quarter or half point increase. Andrew Bailey, the Bank’s governor, said earlier this week that both would be on the table at the MPC’s early August meeting.
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The UK’s annual inflation rate, which rose to 9.4% in June, is expected to reach 11% by the end of this year, stepping up pressure on the standard of living it is already threatening to do. backtracking the economy. Capital Economics is convinced that the Bank will continue to raise rates to 3%, although this will mean that it will do so while the economy is in recession for the first time since 1975.
Others think the MPC will be easier as it struggles with 1970s-style stagflation. James Sproule of Handelsbanken believes the Bank will stop raising rates when they reach 1.75%.
The choice, as Michael Saunders said in his farewell speech as an MPC member last week, comes down to whether the Bank, the Fed and the ECB would rather risk doing too soon or too little too late. Two things are certain: an “whatever it takes” inflation approach will be costly, and the credibility of the three banks is firmly at stake.