One of the most important events of this year was today. The European Central Bank (ECB) was about to raise the interest rates for the first time in years, and this decision will have a more significant impact on the world than we think.
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ECB raised interest rates
It all started with the raging inflation all around the world. In comparison, the US and EU have about 8 to 9 percent, while some developing countries like Turkey fight 80 percent inflation. As a result, many countries now tighten their economies by cutting interest rates. Fed started lowering interest rates earlier this year, and ECB joined today.
The ECB announced that it would terminate its 9-year experiment with negative official interest rates by raising the rate on its deposit facility. This effectively sets the floor for euro money market rates by 50 basis points to 0 percent. Additionally, both the refinancing rate and the marginal lending rate will increase by 50 basis points to 0.5 percent and 0.75 percent, respectively.
The annual inflation rate in the Eurozone grew by more than expected to 8.6 percent in June, which is well above the desired long-term level of 2 to 3 percent. If this rate hike helps to get inflation under control, ECB will not have to raise the interest rates too abruptly or frequently. However, many countries from all around the world recorded increased inflation gradually every month this year. Therefore, stopping it will probably not be as easy as some people think.
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Will history repeat itself?
When looking at the EU inflation, it is constructive to look at the US as well because ECB follows what Fed does most of the time. Now this is only the first rate hike in 2022, and it is expected they will raise them even more, to catch up with Fed. There was a very similar situation in the late 1970s in the US, and inflation was getting out of control.
The interest rates were raised to a staggering 17 percent. That is what really helped and stopped inflation from rising even more. Although this step caused a massive recession in 1982, it also set the ground for a decades-long period of declining inflation and interest rates. Moreover, there was a long-lasting bull market in stocks, bonds, and other similar assets.
It is premature to claim that this great era has come to an end. However, there is more than just a similarity between the price increases and interest-rate instability that characterized the 1970s. Even while harsh fiscal and monetary policies that have always had inflationary effects were the ones that initially caused rising prices, it was believed then, as it is now, that inflation could be controlled by half-measures that would not harm the economy.
The bottom line
We are only about to find out whether modest measures will stop inflation from rising in a few months. But if not, there will probably be some drastic steps that central banks all over the world will have to undertake. Of course, this could cause even more chaos in the economy and in financial markets, but it would be necessary as this is a proven method for taming inflation.