Inflation in the eurozone is over eight percent. The euro and the dollar are equal for the first time in 20 years. Plus, there is also a government crisis in Italy. Against this background, on July 21, a meeting of the Council of the European Central Bank (ECB) will be held to decide on its future monetary policy.

ECB President Christine Lagarde at the last council meeting in June announced a radical change in monetary policy: for the first time in 11 years, the regulator will raise the key rate from record low zero. For starters, according to her, by 25 basis points, although the market is no longer ruling out a rise of 50 points.

A further increase is expected in September. The days of negative interest rates in the euro area will end there. But some banks have already begun to respond by ceasing to take money from customers for placed deposits.

Why the ECB is slowing down with the rate

The big question is how quickly the ECB will raise interest rates. “The ECB reacted too late,” said Gertrud Traud, chief economist at German bank HELABA. Against the backdrop of historical high inflation in the euro area – 8.6 percent – she calls the situation critical: “Central banks around the world have already raised rates, the ECB must also show that it wants to seriously fight inflation.”

Joachim Nagel

Joachim Nagel

The pace and extent of monetary policy normalization remain controversial – including within the ECB’s board. Thus, the head of the Bundesbank, Joachim Nagel, who is a supporter of a tight monetary policy, proposes to raise rates to a level that would slow down economic activity in the euro area. Opponents of the opposite camp, who favor a more gradual rate hike, warn of the risks of a recession – primarily due to the consequences of the war in Ukraine.

Even if the ECB takes only a small step in raising the key rate, it is important, says Gertrud Traud. This would be a signal that the European regulator is ready to raise rates after September, in order to adhere to its goal of keeping inflation at the level of two percent and ensuring the stability of the euro.

ECB in a difficult situation

Now the ECB is in a difficult situation. On the one hand, he must normalize monetary policy. But if you hit the brakes too hard, it will negatively affect the economic environment. “As regards energy priceshe still can’t do anything,” says Martin Lück (Martin Luke), chief economist at Blackrock investment company. In such a situation, in his opinion, it is necessary to achieve lower prices for other goods and services.

Many recession feared in the euro area. Especially against the backdrop of a possible shutdown of gas supplies via the Nord Stream pipeline. The period of planned repairs, after which supplies should resume, expires on July 21 – exactly on the day when the ECB meeting on the rate will take place. To normalize monetary policy, as Luke puts it, means to keep the interest rate “balanced” at which the economy will accelerate rather than slow down. What is this balanced level in the euro area at the moment, it is difficult to determine, the expert adds.

The ECB may also come under pressure due to the widening gap between interest rates in Europe and the US. After US inflation reached 9.1 percent in July, the US Federal Reserve is expected to raise its key rate from its current level of 1.5-1.75 percent by another 75 basis points. This puts additional pressure on the euro, which has already fallen to parity against the dollar last week.

In addition, the government crisis in Italy, which is closely watched by the financial markets, is exacerbating the situation. Prime Minister Mario Draghi is still in office, but how long this will last is unknown. Early elections could be held in the country in October, and if the new government is led by Eurosceptics, this is likely to lead to severe turbulence in the government bond market in the eurozone, said Edgar Wolk, chief economist at Metzler Bank.

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