InvestorQ : What does the European Central Bank (ECB) hiking rates by 75 basis points really mean for India and other countries?
Aashna Tripathi made post

What does the European Central Bank (ECB) hiking rates by 75 basis points really mean for India and other countries?

Aditi Sharma answered.
4 weeks ago

It only in July 2022 that the European Central Bank (ECB) had hiked the interest rates by 50 bps from -0.50% to 0.00%. Now in September, the ECB has implemented another 75 basis points rate hike from 0.00% to 0.75%. If you look back in history, this is the biggest single shot rate hike by the ECB ever since the Euro was first introduced in the year 1999. The ECB, it may be recollected, had kept interest rates deliberately in negative zone since 2014 in a bid to spur spending and combat low inflation. Now it is fighting high inflation, suddenly.

Inflation in the Euro zone at 9.1% is closing in on double digits. For the calendar year 2022, the average inflation is projected at 8.1%, while it is pegged at 5.5% for calendar year 2023. However, by the calendar year 2024, the inflation is expected to finally fall closer to 2.3%, which is just around its long term target median rate of 2% interest levels. The quantum of the spike in interest rates was rather surprising, but then the markets had already factored in this hike in rates considering the nonstop spike in inflation in the Euro zone.

The culprit in the entire story is energy inflation, which has been caused first by the Russian war with Ukraine and secondly with Russia shutting down the Nord Strom 1 pipeline after the EU also participated in US sanctions on Russia. Energy has deep externalities so even other items like food inflation and core inflation have joined the chorus. August inflation in the Euro Zone touched 9.1%, with inflation pressures visible across food, clothing, cars, household appliances and services. But these rate hikes could give rise to a new problem!

Inflation has to be controlled by tight monetary policy has a huge downside risk. Too much anti-inflation stance can trigger a recession in the 19 EU economies. Many of them are already vulnerable. GDP across the euro zone grew by just 0.8% in the June 2022 quarter but like in the US, even in the Euro zone, the consumer spending is not getting squeezed as quickly as expected. That is largely because, despite extremely tight labour market, the rate of unemployment stands at a record low of 6.6%. The dilemma is the same like the US.

Lagarde is clearly hawkish like the US, UK and India. Among global economies, there is a rather tentative Japan and a still dovish Chinese central bank. RBI turned towards a hawkish approach in tandem with the Fed to avoid monetary divergence risk. India does not have much to worry. For now, the ratification from Europe would enthuse the US Fed to go ahead with another 75 bps rate hike in September possibly 50 bps in November. For now even the RBI does not have reasons to give up its hawkishness in a hurry.