“It will be more expensive and complicated to take out loans”

This is the first time since 2011. The European Central Bank (ECB) will raise its interest rates in July. This was announced by its president, Christine Lagarde, this Wednesday. “After the first rate hike, the normalization process will be gradual,” said the leader, who has been speaking since April of a “journey” in stages, hinting at other rate hikes that will come after the first start of the summer.

A decision that involves fighting inflation, which is reaching record levels in the euro zone. Stéphanie Villers, an economist specializing in macroeconomics, explains to 20 minutes the consequences of this measure.

What is happening with the ECB?

The European Central Bank will carry out a monetary tightening with an increase in interest rates. This increase follows the policy of other central banks, such as the Fed, the US central bank or the Bank of England (BoE). In early May, the Fed raised its benchmark rates by 0.5 point and the BoE raised its rate to its highest level since 2009. This rate hike is supposed to fight inflation. It reached the record rate of 7.5% per year in April in the Euro Zone and exceeds 8% in the United States.

How does raising interest rates help fight inflation?

We’ve all heard real estate advice in our lives: “Now is the time to buy, because rates are low.” Well, the idea is to do the opposite: when interest rates are high, you don’t buy less, you don’t borrow less, whether it’s family or business. High interest rates make investments less attractive, because loans are more expensive, so investments decline, as do business output and household purchases. We slow down the economy and therefore slow down inflation. As there is less demand, prices stabilize or fall.

We must be careful not to raise rates too quickly and sharply, because an excessive slowdown in the economy could lead to a recession. It’s a fair mix, which is why Christine Lagarde talks about raising rates, then going back to normal, then raising them again… It’s a delicate balance.

Is it therefore a good solution to calm inflation in the euro zone?

There is a problem in this strategy regarding the Euro Zone. In these countries, inflation is linked to the rise in energy prices or the price of imported agricultural products, that is, products purchased outside the euro zone. Even if the ECB raises its interest rates, it will not change the price of Russian energy, so it is not certain that inflation will slow down. You have to understand that we have an external inflation in a certain way, so it is more difficult to act accordingly.

In the United States, it is an inflation caused mainly by the increase in wages. For once, the rise in interest rates has a real impact: companies will have less capacity to invest, therefore they will hire less and therefore reduce wages, which will have an effect on inflation.

Is the ECB making an unnecessary decision?

Not anyway. First, it will continue to have an even smaller impact on inflation. Second, it makes the euro credible again against the dollar, which has been strongly preferred since the Fed’s interest rate hike. The rich prefer to invest their money in the United States, with more profitable interest rates. In France, currently, the 10-year interest rate is 1.5%, while in the United States it is 3%. Inevitably, investing your money in the United States is much more profitable and profitable. The mission of the ECB is not to maintain the value of its currency, but it was not going to stop doing so and the fight against inflation is a very good excuse.

What does this change for households?

It will be more expensive and complicated to take out loans. It has already started: banks are less and less flexible in their ability to grant credit: they ask for more guarantees, terms and less money to get out. Conversely, with high interest rates, savings run the risk of becoming more profitable. In particular, we can anticipate a future rise in livret A, to bring it in line with ECB interest rates. And more money saved means less consumption, and therefore less inflation.