The European Central Bank’s (ECB) first rate hike since 2011 was prompted by rising inflation but will bring no relief from ever-rising household bills or business expenses. At least not in the short term.
That’s because the money supply – which is dictated by interest rates – accounts for a relatively small part of what’s fueling inflation in Europe.
By far the biggest drivers of inflation are energy bills, which spiraled out of control after falling to all-time lows during the Covid-19 pandemic and then peaking as factory and transportation demand recovered.
Raising interest rates will not accelerate the reconnection of trading patterns and relationships strained by lockdowns
Rising interest rates will not boost the supply of oil or gas, nor will it make renewable energy more efficient. Ditto for industrial supply chains – the next big driver of inflation. Raising interest rates will not accelerate the reconnection of trading patterns and relationships strained by lockdowns. Indeed, in the short to medium term, higher interest rates will drive up bills for hundreds of thousands of mortgage borrowers and increase the cost of borrowing for businesses.
Why is the ECB doing this? The ECB is trying to cool inflation, not so much now, but 18 months from now.
Inflation is brutally high, not only well above the ECB’s target but also above all previous forecasts. It is also expected to linger, not at current levels but higher than policymakers are comfortable with.
But the central bank has no tool to really dampen inflation in the short term. Instead, rate hikes are now expected to cool industrial investment, speculative construction, and mergers and acquisitions through rising borrowing costs. Over time, this hurts economic growth to mitigate rising costs.
The US started raising interest rates in March and is now up 1.5 percentage points from our 0.5 percentage point. The US is less dependent on energy imports than Europe and loose money is a bigger driver of inflation there, so rate hikes should have a quicker impact than here. But US inflation has continued to rise, leaving American borrowers hammered on their mortgages in the near term and not getting relief on their weekly purchases.
But in the background, rate hikes are starting to take hold. The technology sector is the clearest example. In the era of ultra-cheap money, parts of the tech sector have depended on steady inflows of new investment to fund dramatic growth, detached from the need to build profitability.
Now that interest rates are rising, the volume of money-hunting in tech investments has plummeted — reaching the face value of companies like Stripe. With no money flowing, tech managers are learning to do more with less; The hiring rate is starting to slow, which in turn will dampen wage growth and demand for bigger cars or home improvements and vacations, and only over time reduce the types of household and corporate inflation that rate hikes are designed to address.
https://www.independent.ie/opinion/comment/how-rate-increases-work-short-term-pain-in-the-in-hopes-of-longer-term-gain-41859330.html How rate increases work – short-term pain in the hope of longer-term gain