The ECB raised the rate - what does it mean. Spoiler alert: nothing good

Rates are calculated in basis percentage points (b. P.). 1 b. P. - 1/100 of one percent, i.e 50 b. P. — 0,5%

There are actually three ECB rates:

1. Rate on main refinancing operations. This is the bet, by which the ECB lends money to banks for a week. This is the base rate..
2. Margin lending rate. This is the bet, on which the ECB gives banks overnight loans, that is, for a day or a little longer - for the weekend. Banks borrow money from the ECB and from each other, so that payments go through instantly, instead of dragging on for weeks and months.
3. Deposit rate. This is the rate of return on deposits, which banks leave with the ECB on overnight loans. Based on this, banks determine, how much will customers be paid on deposits.

Deposit rates are no longer negative and are now zero, while margin lending and refinancing rates rose by 50 b. P.

Change in ECB rates

All three stakes are like different buttons and levers in a recording studio: they can be moved at the same time, how it happened recently, and can be separately.

For example, from 2016 to 2019, the rates on margin lending and refinancing of the ECB remained the same - 0.25% and 0%, respectively, but on deposits it lowered from -0.4 to -0.5%.

With the help of all three rates, the ECB regulates the eurozone economy.

If inflation is too high and prices of everything rise too fast, raise the base rate, to limit consumption and slow down price increases.

If consumption is low and prices do not rise or even fall, because no one buys anything and even reduces consumption, ECB cuts rates, to stimulate consumption.

Low and high inflation - Scylla and Charybdis of each central bank.

Therefore, central banks set plans for average annual inflation: what it should be. At the moment, the ECB had a plan to keep average annual inflation within 2%. But failed to complete it..

The higher the ECB rate, the more expensive the loans will be and the higher the deposit rates will be. We have already told, how key rate works, on the example of the Russian Federation.

If the rates are low, deposit rates are falling, their profitability becomes less attractive and investors withdraw this money to countries, where the stakes are higher. So when the rates drop, falling and the value of the country's money, in which rates have been raised.

And vice versa: if rates go up, deposits become more interesting and the exchange rate grows.

When was the last time the ECB raised rates?

The last time the ECB raised interest rates was in 2011., with 1 to 1,5%. This led to a slowdown in business activity., decrease in consumer activity and, what is especially important, to a new round of the debt crisis. To a number of countries - Ireland, Greece, Spain, Cyprus - it became harder to pay its considerable debts. Portugal's national debt has received the status of "junk", i.e. speculative, and the Greek debt generally had to be restructured, to avoid country default.

Eventually, to stimulate economic growth, rates started to come down again.

What is an asset buyback program and why is it needed?

When the stakes are so low, and the economy is still marking time and consumption is not growing, The Central Bank can experiment.

In 2015, the ECB launched a program to buy assets from different types of investors, not just banks and pension funds., but also for households, buying reliable securities for tens and hundreds of billions of euros, e.g. government bonds. As a result, banks receive new money, who then invest and lend at not very high rates. Thanks to this, there were many companies in Europe, who would go bankrupt, don't be this program.

From 2015 to the present, the ECB has bought securities worth 3.438 trillion euros, but some of them sold. That is, in addition to rates, the ECB uses an asset buyback program to regulate the economy.

Why Raise Now

Due to inflation. This year, inflation in the eurozone reached 8,6%, which is more than four times higher than, what does the ECB want, — 2%.

Basic moments, that drove inflation in the Eurozone:

1. Pandemic and quarantines led to a drop in demand and shutdown of enterprises. Then the restrictions started to loosen., people increased consumer activity faster, how to restore production, as a result, there was a shortage of goods and prices rose.
2. Due to constant logistical disruptions, caused by the pandemic, delivery times are extended, prices are rising.
3. After 24 February prices for raw materials and energy rose, and logistical problems multiplied: skies over Russia are now closed to most countries.
4. Euro and dollar in the first half of July began to cost the same, that is, they reached parity. Moreover, taking into account all the circumstances, there was a trend towards a further decrease in the euro. The EU benefits from a more expensive euro, since for oil and gas they are mainly calculated in dollars: when the euro depreciates, raw materials become more expensive.

Now the euro is worth a little more than the dollar - 1,01 $ — and the news about the rate hike hasn’t affected its course much yet.

In the US, the local central bank (FED) also raises the rate - for a year from 0,25 to 1,75% - and also to fight inflation. English Central Bank (Bank of England) raised the rate to 1% is the highest level for 13 years.

What will be the consequences of this

Inflation in the eurozone should fall. How the ECB hopes, As a result of the rate hike, inflation this year will fall to 6,8%, will slow down even more in 2023 to 3,5% — and already in 2023 will be 2,1%.

The threat of a recession has become more real. Raising rates equals slowing economy. The ECB has already cut its economic growth forecasts in the eurozone countries: with 3,7 to 2,8% in 2022 and from 2,8 to 2,1% in 2023.

At all, before the rate hike, everyone was talking a lot about the risks of a recession, And, worth saying, increase in the cost of loans, resulting from the increase in rates, can really cause this recession.

For debt-ridden countries, there is a threat of default. Rising deposit rates reduce demand for government bonds, which give a small return. This will drive up the cost of loans., because investors will expect a higher percentage, than that, what do they get now. This is bad for debt-laden countries like Italy, whose debt is 150% GDP, and increases the risk of default. So, from the news about the ECB rate hike, the value of Italy's ten-year government bonds fell and their yield rose by 0,27 b. P. to 3,7% per annum.

Truth, ECB plans to use transmission protection tool to forestall defaults (transmission protection instrument, TPI) - he will buy government bonds with a maturity of 1 year to 10 years of countries, if their price fluctuates too much "not due to purely domestic factors", that is, from the speculative collapse of their value. This is how the ECB will create demand for these securities, which will restrain the growth in the cost of loans for problem countries and reduce the risks of their default.

Also the ECB, maybe, will buy corporate bonds, which is logical: in some countries, large holdings can play a big role in the economy, e.g. Mercedes in Germany. Truth, no specifics on TPI yet.

Growth rates of European companies will slow down. Higher rates mean lower inflation, consumption and investment. So the production of goods and consumption of services will slow down along with inflation.. European goods abroad will rise in price, because the euro will rise in price, which means, export earnings will fall. It will be felt: which European companies I have not reviewed - BASF, Hapag-Lloyd and others, they are all leveraged and make most of their money outside the eurozone.

At the same time, the attractiveness of shares of European companies for investors will decrease.. Rising deposit rates may lead to an outflow of people's funds from the exchange, who are not ready to tolerate volatility, but at the same time they want, to make money work.

Stoxx European Equity Index 600 from this news fell on 0,2%, but this, frankly,, not very much - we have not yet seen the real consequences of the rate increase.

The euro will rise. On such news, the euro exchange rate will rise, but you need to understand, what if the US also raises rates, the dollar will go up, offsetting the difference.

Commodity prices will fall, and this will put pressure on the ruble. On the news about the ECB, the euro against the ruble, certainly, grew up on 5%, but for the Russians the situation is paradoxical: ECB rates up, and the euro is cheaper, than a year ago, — 58,27 R vs 77 R. So this decision will not have a significant effect on the ruble.

But at the same time, a decrease in economic growth will mean a reduction in the consumption of raw materials, including. So,, Commodities are waiting for the fall in prices. Oil prices have already fallen by 3,3%, and this in the future may affect the ruble.