The European economy is in a lot of trouble – What’s ECB doing?

As Europe stumbles through a period of economic turbulence, all eyes are firmly planted on the European Central Bank (ECB), the watchdog tasked with stabilizing the continent’s economic heartbeat.

Remarkably, the ECB has cranked up interest rates to a record high last seen in 2001, marking its ninth straight increase. A move echoing the US Federal Reserve, which boosted rates by the same margin, is nothing short of controversial.

ECB: Making waves amid stormy seas

Following the tide set by its transatlantic counterpart, the ECB pushed its fundamental deposit rate up by 0.25 percentage points, bringing it to a cool 3.75%.

Two decades ago, it embarked on a similar path, intending to inflate the fledgling euro’s worth. However, the times have changed, and the repercussions are drastically different.

This interest hike barely caused a ripple in investor confidence. Market players seem to believe that we’ve seen the peak of the hike mountain, as inflation rates on both sides of the Atlantic are descending at a quicker pace than predicted.

Krishna Guha of Evercore ISI boldly asserts that both the ECB and the Federal Reserve are likely finished with their rate-hiking spree, although he notes a lingering risk of additional hikes.

Is Europe’s economic tightrope tightening?

The ECB’s maneuvering had an instant effect on Europe’s financial landscape. The euro took a hit, dipping 0.5% to $1.103 as hints of the bank wrapping up its tightening campaign emerged.

Comparatively, the US dollar basked in the glow of a surprisingly robust GDP report, with the economy expanding at an annualized rate of 2.4% in Q2.

In the bond market, yields on the 2-year German bond receded by 0.08 percentage points, dropping to 3.19%, while the 10-year yield fell by 0.05 percentage points to 2.4%.

ECB’s policy shift aims at keeping interest rates at levels “sufficiently restrictive” to suppress inflation down to the 2% target.

However, ECB President Christine Lagarde introduced a slight alteration in the bank’s rhetoric, stating that interest rates will remain at restrictive levels “for as long as necessary.”

This change isn’t insignificant. Current price pressures are hovering around 5.5%, nearly threefold the target, indicating that the bank is considering all options on the table.

Europe and its economic quagmire

Inflation in Europe has receded from a towering 10.6% last year, and a further decline is expected. However, the ECB continues to beat the drum of caution, warning that inflation is set to linger at uncomfortable highs for an extended period.

Bolstering this position, the ECB unveiled a change in its inflation narrative, signaling greater assurance that price pressures are finally taking a downhill route.

Instead of seeing only “tentative signs of softening” in price pressures as previously stated, the bank now acknowledges that, while some measures are easing, underlying inflation remains high.

To save on interest expenses, the ECB is lowering the rate it pays on mandatory reserves held by banks. The intention is to enhance its policy rates’ effectiveness in money markets.

However, critics argue this could diminish banks’ willingness to pass on ECB rates to depositors, adding another layer of complexity to Europe’s economic challenges.

As Europe battles economic adversity, the ECB’s strategy has become the topic of much discussion. While its efforts might bring temporary relief, the underlying economic complexities call for more comprehensive and long-term solutions. Only time will tell if the ECB’s gamble will ultimately pay off.

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