Central banks are there to fight inflation, but in recent crises (financial, sovereign debt, Covid-19) their main concern has been setbacks. (Photo credits: Federal Reserve ECB – )
You don’t need a sophisticated interest rate forecasting model to say that interest rates will continue to rise. According to Catherine Lubochinsky, the question “how far” can they go is all the more delicate as the answer depends on the rates attributed, and above all on what horizon.
In the short term, the next hikes in intervention rates have already been recorded by the financial markets. With the return of inflation, references to the 1980s multiplied, a period during which these rates exceeded 10% (17% for the Banque de France in 1984) until the oil counter-shock of the second the mid-1980s saw a decline in inflation. How high court rates can reach therefore depends on consumer inflation.
Central banks are there to fight inflation, but in recent crises (financial, sovereign debt, Covid-19) their main concern has been setbacks. The task was relatively easy in a context of price stability (or even the risk of deflation), obviously more complex for the ECB which must simultaneously manage the risks of fragmentation in the euro zone.
This transatlantic difference is even more striking today for three reasons: on the one hand, the factors explaining the different inflation (demand shock vs. supply shock and the differentiated impact of the energy crisis resulting from the war in Ukraine) and therefore the effectiveness of a rise in the intervention rates of the central banks to curb the different inflation, which leads to predicting a sharper rise in rates in the euro zone. Moreover, the maximum employment rate is an explicit objective of the FED, whereas the main explicit objective of the ECB concerns only price stability. Finally, the ECB has to deal with an increased divergence of inflation rates in the euro zone. The annual inflation rate for September 2022 amounts to 9.9% within the euro zone (8.2% for the USA) but ranging from 6.9% for France to 24.1% in Estonia, in September 2022.
However, it is reasonable to assume that the foreseeable rise in key central bank rates is limited. In fact, two factors must be taken into account.
On the one hand, their concern about the consequences on economic activity (explicit or implicit); on the other hand, especially in the euro zone, the consequences in terms of financial stability. Specifically, the rise in court rates can continue as long as these rates correspond to real interest rates. Positive real interest rates in an environment of very weak GDP growth seem unlikely.
The second factor concerns the impact on long rates and the steepening of the yield curve (linked to the end/slowdown of Quantitative Easing). The steepening is undeniable on both sides of the Atlantic, with rates anticipating a continued rise in central bank intervention rates. This rise – more than the level itself – in long rates poses a problem given the debt ratios of Western economies. This is the case for public debt ratios, the heterogeneity of which in the euro zone translates into an increase in default risk premiums (10-year rate in Italy at 4.60% for a rate in Germany at 2.43 %). Hence the need for an “anti-fragmentation” program by the ECB.
To those who advocate a very sharp rise in ECB rates, remember that, according to FIPECO calculations, if a 1 point rise in the inflation rate generates an additional cost of 2.2 MSD euros on the indexed public debt, an increase (on January 1) of 1 point in all interest rates (parallel shift in the yield curve), results in an increase in the interest expense of €2.5 billion in the first year, up to to €29.5 billion in the tenth year.
Central banks are therefore reacting to inflation for the time being. Suppose they are effective. The long-term explanatory factors of the real rates (demographics, productivity, massive investment needs for the climate, etc.) lead to predict that the latter must remain low for a long time.
Catherine Lubochinsky, member of the Circle of Economists
Professor at the University of Paris II