“On the way to a full-fledged recession”: how the first ECB rate hike in 11 years could threaten the eurozone economy

On Thursday, July 21, the Board of Governors of the European Central Bank (ECB) decided for the first time since 2011 to raise its base interest rate from 0 to 0.5% per annum.

This is stated in the regulator's press release published following the meeting.

Also, the ECB management approved an increase in rates on deposits (from -0.5 to 0% per annum) and on short-term loans (from 0.25 to 0.75% per annum).

The monetary authorities of the eurozone explained their actions with the intention to restrain the growth of consumer prices in the region.

“This decision is based on an updated assessment of inflationary risks ... It will help return inflation to a medium-term target ... Further normalization of interest rates will be appropriate at the next meetings of the Board of Governors,” the ECB said.

According to Eurostat, in June 2022, prices for goods and services in the euro area increased by an average of 8.6% compared to the same period in 2021.

This level of annual inflation was the highest for the entire period of observation and more than four times exceeded the target level of the ECB (2%).

Today, in about half of European countries, annual inflation exceeds 10%.

At the same time, in some states of the region (Lithuania and Estonia), the figure has already exceeded 20%.

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Price growth in Europe began to noticeably accelerate as early as 2021.

Then the measures of the EU authorities to combat the consequences of the coronavirus pandemic had an impact on inflation, said Alexander Razuvaev, a member of the Supervisory Board of the Guild of Financial Analysts and Risk Managers.

“At that moment, inflation was mainly monetary in nature.

The fact is that during the pandemic, the governments of European countries were actively printing money to support their economies and populations, which could not but affect prices, ”the source explained to RT.

Later, a sharp rise in the cost of energy resources played in favor of accelerating inflation, experts emphasize.

As Artyom Deev, head of the analytical department at AMarkets, told RT, the increase in the cost of oil, gas and electricity along the chain led to an additional increase in prices for absolutely all groups of goods.

“Since the beginning of this year alone, electricity for retail consumers in Europe has risen in price at least three times, and for business and industrial enterprises - five times.

Today, this is one of the key factors in the growth of inflation in Europe, and a long-term one," Deev said.

As Russian President Vladimir Putin explained earlier, the main reason for the observed price dynamics was the mistakes of the European authorities in the field of energy.

So, at one time, the EU leadership made a bet on renewable energy sources and decided to abandon financial investments in the oil and gas industry.

“They are great experts in the field of non-traditional relations, so in the field of energy they also decided to rely on non-traditional types of energy: the sun, wind energy.

The winter was long, there was no wind - that's all.

And investments in fixed capital in traditional energy disappeared due to earlier political decisions, ”Putin explained.

At the same time, sanctions against Russia only aggravated the situation, the head of state believes.

In response to the conduct of a special military operation in Ukraine since the end of February, Europe, together with the United States and a number of other countries, continue to introduce ever new economic restrictions against Moscow.

In particular, the European Union decided to abandon the import of coal and oil from the Russian Federation.

In addition, Western restrictions have had a negative impact on Russian gas supplies to the EU.

“The volume of gas in the European market has decreased and the overall price in the market has risen.

Who did win?

All Europeans only lost,” Vladimir Putin explained.

It is noteworthy that the general deterioration of the situation in the eurozone economy had a negative impact on the dynamics of the national currency of the region.

Since the beginning of 2022, the euro on the world market has fallen in price against the dollar by about 10%.

Moreover, in mid-July, the European currency at some point even cost less than the American one - for the first time in the last 20 years.

“First, the EU members shot themselves in the head with a sanctions pistol.

Now they are reaping the bitter fruits of a decline in production, supercritical food inflation, the loss of competitiveness of their goods and the expectation of winter in ice dwellings without our gas.

In global terms, this is confirmation of the extremely ill-conceived nature of the sanctions against Russia,” Dmitry Medvedev, Deputy Chairman of the Russian Security Council, noted earlier.

"All manifestations of the crisis"

Curiously, over the past six years, the European Central Bank has consistently kept the base interest rate at 0% per annum.

As Artyom Deev explained, in this way the ECB tried to stimulate consumer demand in the eurozone and the economy of the region as a whole.

However, the policy of the regulator did not justify itself, since consumption did not grow at the required pace, experts say.

“Moreover, at some point, the ECB even thought about setting a negative base rate in order to revive the economy and activate the stock market.

However, the idea remained on paper, and the regulator stopped at zero,” Alexander Razuvaev added.

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According to Artyom Deev, in theory, an increase in the interest rate should lead to an increase in the cost of loans for the population and businesses, a reduction in the circulation of money in the economy and a slowdown in inflation.

In addition, the tightening of monetary policy is designed to strengthen the European currency, as investments in the euro should become more profitable for investors.

However, in practice, the European Central Bank is unlikely to achieve such results, the analyst believes.

In addition, in his opinion, in the current environment, a rate hike could further weaken economic activity in the eurozone and push countries in the region into recession.

“Raising the rate to 0.5% with inflation of 8.6% will not solve anything.

The cost of energy carriers will continue to rise, because due to sanctions against Russia, the shortage of raw materials will continue to increase.

Therefore, by the end of the year, Europe will see double-digit inflation,” the analyst believes.

In his opinion, at the moment the ECB cannot afford to tighten monetary policy more resolutely to curb inflation.

Thus, taking into account the high level of public debt in a number of eurozone countries, a sharp increase in interest rates could result in a series of defaults.

Italy and Greece, for example, may face such a situation, the expert did not rule out.

“Europe is now on the path to a full-fledged recession, which is well understood by investors who are withdrawing capital from Europe to the United States.

Therefore, in the future, we are likely to see a further weakening of the euro against the dollar, as well as all the manifestations of a serious crisis in the eurozone.

In addition to accelerating inflation, we are talking about the deterioration of the financial market, bankruptcies of enterprises and rising unemployment,” Deev concluded.