Interest rates: More gradual but overall bigger increase from European Central Bank and Fed

The message sent by the European Central Bank (ECB) and the US central bank (Fed) last week is that inflation will fall, but at a slower pace than expected, so interest rates will have to rise more overall and remain at high levels for a longer period of time.

The hike decided on Thursday by the ECB and the day before by the Fed may have been smaller than those previously announced – half a percentage point instead of three-quarters of a point – but the level at which interest rates will peak will is higher.

In other words, the adjustment of interest rates towards their final station will be more gradual but will also last longer. Correspondingly, the installments that borrowers will be required to pay will rise less sharply from now on, but the bill will eventually be bigger.

ECB President Christine Lagarde specified that the next hikes would also be half a percentage point, but hinted that there would be enough in 2023, saying there was still a lot of ground to be covered and a long way to go.

Lagarde said the market’s estimate that the final ECB deposit rate would be 3% did not match the central bank’s inflation forecasts, implying, implicitly but not clearly, that the final rate was intended to reach significantly higher than this level. Given that the deposit rate currently stands at 2%, at least three more half percentage point increases from the ECB should be expected.

Rising interest rates, together with the energy crisis and related uncertainty, are expected to contribute to a significant slowdown in the Eurozone economy in 2023. The ECB estimates that GDP may contract in the current and next quarters, but for the whole of next year foresees a marginal increase of 0.5% which will strengthen to 1.9% in 2024.

Although US inflation is lower than in the Eurozone, as interest rate hikes started earlier and the energy crisis is less severe, the Fed estimates that a return to the 2% target will not be possible before 2025.

Specifically, the personal consumption expenditure price index is forecast to fall to 3.5% in 2023 and 2.5% in 2024. By comparison, the ECB sees the harmonized consumer price index falling to 6.3% at mid-levels in 2023 and to 3.4% in 2024 from 8.4% this year.

Despite the easing of US inflation in recent months, the Fed believes there must be further rate hikes to reach the 2% target. Its executives’ average forecast is for the key rate to reach 5.1% next year, three-quarters of a percentage point higher than it is today.

For the growth of the US economy, the Fed’s forecasts are in line with those of the ECB, i.e. 0.5% for 2023 and 1.6% for 2024.

RES-EMP

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