European Central Bank considers substantial interest rate increase against inflation

European central bankers are considering raising interest rates faster to tackle high inflation. This is what President Knot of De Nederlandsche Bank says in an interview with the NOS. He calls for an increase of at least 0.5 percentage points and possibly even 0.75 percentage points in September.

“The inflation problem in Europe at the moment is so great that I think our task is to raise interest rates every six weeks until the inflation picture stabilizes around 2 percent,” says Knot. Inflation in the eurozone averaged 9.8 percent in July, partly as a result of sharply higher energy prices.

Knot is currently in Jackson Hole, USA. The annual symposium there is also called a festival for central bankers. The keynote speaker today was Jerome Powell, president of the US central bank.
How do interest rates curb inflation?

A higher interest rate makes saving more interesting and borrowing less interesting. This will make businesses and consumers less likely to spend money. As a result, demand decreases and prices rise less rapidly.

“Inflation is always caused by spending more on goods and services than is available,” says Klaas Knot. According to him, this gap between supply and demand can arise because citizens and companies are spending more money, for example after the corona crisis. Or because there is suddenly a shortage of goods (such as gas or grain) due to the war in Ukraine.

“The fact that there is a gap creates inflation,” says Knot. “We can only close that gap by reducing demand.”Lower demand leads to lower inflation, that’s the idea.

Powell was shorter and more resolute than in previous years: inflation must be tamed, preferably back to 2 percent. “The pain of high inflation is felt most by those least able to bear the burden,” Powell said on the second day of the symposium. A strong policy to tackle this inflation is therefore necessary, including further interest rate increases.

But higher interest rates will also hurt households and businesses. Higher interest rates – especially over a longer period of time-will lead to less economic growth. As a result, people can lose their jobs and companies get fewer orders.

“I think Powell’s speech has been pretty clear,” says Knot. “At the moment, our inflation problem is so great that we really need to focus on inflation and take the consequences for our economic activity for granted.”

Bun was not the only one who closely followed the speech of his American colleague. Investors around the world were eagerly awaiting Powell’s words. They hoped he would strike a different tone. Higher interest rates are usually bad for stock prices.

Powell’s resolute tone therefore fell badly on the US stock exchanges. He had barely uttered his last words before the S & P 500 began to decline. An hour after the speech, the index stood at -1.5 percent. The Dow Jones and Nasdaq also declined.

US inflation averaged 8.5 percent in July. To tame them, the interest rate has already been increased in four steps in recent months to between 2.25 and 2.5 percent. The last step was one of 0.75 percentage points. There will be another increase in September.

The European Central Bank (ECB) has been even more cautious so far, although inflation in the eurozone is higher than in the US. In July, the ECB raised interest rates by 0.5 percent for the first time since 2011. The European interest rate is therefore no longer negative for the first time in eight years.

The interest rate is now exactly 0 percent.

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