Will central bank’s decision help overcome soaring fuel prices?

This is a sign of firm determination to curb historical inflation. The European Central Bank has decided to raise interest rates for the first time in 11 years.

The central bank will raise its key interest rate from 0% to 0.5%. The ECB’s interest rate on deposits from private banks will be lifted from minus 0.5% to 0%.

After eight years, the bank’s negative interest rate policy will come to an end. The ECB had previously announced a rate hike of 25 basis points, but it ended up doubling that figure.

The eurozone’s consumer price index rose 8.6% in June from the same period last year, the highest-ever increase, due to soaring energy prices following Russia’s invasion of Ukraine.

“Price pressures are spreading across more and more sectors,” ECB President Christine Lagarde said, stressing the need for vigilance. In Italy, Prime Minister Mario Draghi came under pressure to resign over public dissatisfaction with inflation. It is reasonable for the ECB to hurry to raise the rates, so as to curb inflation.

However, concerns over the future of the economy are growing in Europe.

Russia is threatening Germany by reducing the amount of its natural gas supplied through pipelines to 40% of the previous level. The European Union has announced a plan for its member countries to cut their natural gas consumption by 15%.

Curtailing the use of gas will deal a blow to industry. If gas prices rise further due to tight supply and demand, the burden on household budgets will increase, adversely affecting consumption.

A rate hike has a negative effect on an economy. The ECB must perform the difficult task of keeping inflation in check while preventing an economic slowdown.

The focus will be on how to deal with Southern European countries that are heavily indebted. When the ECB indicated its intention to raise interest rates in June, the government bonds of countries such as Italy and Spain plunged, causing interest rates to rise. When interest rates increase, the burden of interest payments swells, further worsening the state finances.

A situation must be avoided in which the European debt crisis triggered by Greece in the first half of the 2010s reignites and disrupts financial markets.

The ECB has introduced a mechanism to buy government bonds and other securities as needed in the event that government bond prices in the bloc plummet. It is hoped that the central bank will provide effective assistance to countries with weak fiscal bases.

Meanwhile, the Bank of Japan has decided to continue its bold monetary easing measures. Now that major U.S. and European central banks have raised interest rates to be in line with one another, the differences have become starker.

The yen may further weaken, which pushes up the prices of imported goods. There are also growing concerns about rising food and fuel prices in Japan. The Bank of Japan should provide detailed explanations as to whether it can overcome the situation by continuing its monetary easing policy.

(From The Yomiuri Shimbun, July 24, 2022)