Doubts whether the ECB’s interest rate increase can counteract inflation

The Eurotower in Frankfurt

With inflation rates in the eurozone at the record level of 4% which is twice the ceiling set by the European Central Bank, the ECB tries to intervene and increased the refinancing rate from 4% to 4.25% today. However, the ECB draw heavy criticism for this step as economists and politicians in Europe argue that raising interest rates in the Eurozone cannot fight imported inflation and has a negative influence on the European economies which are deteriorating right now. Soaring food and energy prices drive inflation and cannot be halted easily. The ECB joined several other central banks around the world (Canada, the Philipines, Indonesia, Brazil, Norway, Sweden…) which respond to alarming inflation levels with key rate increases. Two thirds of the earth’s population have to struggle with double digit inflation rates and especially in Asian countries inflation seems to have got out of hand. With inflation at 26.8% in Vietnam and 11.42% in India, there’s a lot of pressure on policy makers to stem the rising prices. However, there are some countries like China that keep their undervalued currencies pegged to the USD and that fear that untying their currencies could lead to a cooldown of their economies.

Jean-Claude Trichet, the ECB’s president, being aware of the risk and unease resulting from this step, he indicated that he’s not planning additional rate increases by saying “starting from here I have no bias on the direction of monetary policy”. This statement caused the Euro to loose more than 1% against the USD as speculants interpret that the ECB is at the end of its line and against expectations will not start a series of rate increases. Trichet pointed out that the ECB also wants to prevent “broadly based second round effects” and warns unions not to demand inadequate wage increases.

Denmark is probably the country hit hardest by the interest rate increase. Denmark participates the European Exchange Rate Mechanism (ERM) and keeps its exchange rate within the range of +/- 2.25%  against the central rate fixing the Danish krone to the Euro. Thus, the Danish National Bank is expected to raise its interest rates as the ECB did. This could be especially painful for Denmark as it is the first European country that has fallen into recession in the aftermath of the US subprime crisis. Official statistics show that the Danish economy has contracted 0.6% since December. Other European economies are also deteriorating significantly and could face recession. Ireland and Spain whose housing markets are down after the longstanding construction boom came to a halt. House prices are plunging and people are spending less.

Our dependence on oil is the culprit for soaring prices and high CO2 emissions. At this point, it is clearer than ever before that reducing our oil consumption is essential and inevitable. By embracing alternatives and pushing forward the existing technologies, we could fight inflation, save the environment and save money.


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One response to “Doubts whether the ECB’s interest rate increase can counteract inflation

  1. Pingback: The electric car revolution is about to happen « What Matters

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