Central bank: ECB cement interest rate low – policy of the “steady hand”

Savers in the euro area will have to prepare for an even longer-lasting slump in interest rates. ECB President Christine Lagarde speaks of a “steady hand” policy and calls for “patience”.

In the first interest rate meeting after the adoption of a new monetary policy strategy, Europe’s monetary watchdogs reaffirmed their expansionary course on Thursday with interest rates at a record low and billions in bond purchases.

“The economic recovery in the euro area is on track,” said Lagarde. “But the pandemic continues to cast a shadow, especially since the delta variant is a growing source of uncertainty.” This could dampen the recovery in service sectors. Under these circumstances, nobody wants to tighten monetary policy too early, said Lagarde.

The central bank, based in Frankfurt, is therefore keeping the key interest rate in the euro area at a record low of zero percent. The most important interest rate for supplying the banking industry with central bank money has been at this level since March 2016. At the same time, commercial banks still have to pay 0.5 percent interest when they park money at the central bank.

“We do not intend to maintain the low interest rates any longer, we want to achieve our goal,” emphasized Lagarde, referring to the new, more flexible inflation target that the ECB had presented in early July. The central bank is now aiming for an annual inflation rate of two percent in the medium term for the 19 countries in the euro area – and that over a longer period of time if possible. “This may be accompanied by the fact that inflation is temporarily moderately above the target value,” affirmed the ECB on Thursday. So far, the ECB’s inflation target has been “below but close to two percent”.

With this “symmetrical” inflation target, the central bank is no longer forced to react immediately if the inflation rates temporarily deviate upwards or downwards from the percentage target. Persistently low prices are seen as a risk to the economy: companies and consumers could then postpone investments – in the hope that it will soon become even cheaper.

“Unfortunately, business and savers will have to live with negative interest rates for a long time to come. And this in spite of significantly rising prices, ”said Christian Ossig, General Manager of the BdB banking association. Inflation in the euro area had risen recently. From the point of view of the monetary authorities, this increase is temporary and due to special factors as a result of the Corona crisis.

With the new interest rate outlook, all hopes “that there may be a rate hike as early as 2023 or 2024”, analyzed Andreas Bley, chief economist of the Federal Association of German Volksbanks and Raiffeisenbanks (BVR). “This extends the endurance test of persistent negative interest rates for savers and the financial sector.”

The ECB will continue the particularly flexible emergency purchase program for government bonds and securities from companies (Pandemic Emergency Purchase Program / PEPP) with a volume of EUR 1.85 trillion that was launched at the beginning of the corona pandemic until at least the end of March 2022. Although doubts about the necessity of such purchases are growing in view of the upturn in the economy, the central bank wants to significantly increase the pace of securities purchases in the third quarter.

The ECB’s bond purchases help states and companies alike: They don’t have to offer such high interest rates for their securities if a central bank is a big buyer in the market. This is especially important for states because during the Corona crisis they launched rescue programs worth billions that need to be financed.

After March 2022, the PEPP purchase program could «possibly … move into a new format», Lagarde had said before the ECB meeting. The future of bond purchases was not discussed in the Governing Council on Thursday, said Lagarde after the meeting in Frankfurt. She emphasized: “Any kind of exit would be premature.”

Last week, Lagarde had once again rejected hopes of an early end to the anti-crisis course: “Now is not the time to talk about an exit strategy.” In their revised longer-term outlook, the so-called forward guidance, the monetary authorities are now emphasizing the aspect of persistence. According to the assessment of the Landesbank Baden-Württemberg (LBBW), the ECB is signaling: “We are in no hurry to withdraw from the ultra-expansionary measures, even if the economic recovery continues.”