Bigger interest rate hikes to be on the table for Europe and UK

Following multiple countries in the world including South Korea and the U.S., Europe which was hesitant about raising interest rate, will take part in currency tightening. Some even foresee possibilities of big interest hikes or a “big step.” If Europe increases its interest rate, it will be an increase in 11 years since the Southern European financial crisis in 2011.

According to the foreign press including the Financial Times (FT) as of July 20, the European Central Bank (ECB) seems almost certain to raise the base rate in its July 21 Monetary Policy Meeting. Since ECB inched up its interest rate last in July 2011, it inched down the interest rate bit by bit and from March 2016, it maintained zero interest rate for over six years.

Originally, the market outlook was dominant that the ECB will lift the interest rate by only 0.25% for ECB already preannounced how much they plan to raise when the ECB decided to freeze its interest rate in June. However, the Euro zone June inflation rate announced this month soared up to 8.6 percent making the argument for the need of a “big-step” to respond to inflation more convincing.

The possible faster than expected interest rate hike in Europe has been fueled even further by the U.S. likely move of so called a “giant-step” (0.75% base rate hike) this month on top of last month. Such the U.S. moves have brought the Euro to dollar exchange rate to the lowest in 20 years instigating the inflation rate. If the ECB decisively takes the big step, the deposit rate (a type of base rate) will also rise from -0.5 percent to 0 percent and the negative interest rate experiment, which continued for some eight years since 2014, ends. The FT reported that the ECB is discussing measures of ending the negative interest rate by increasing the rate by 0.5 percent and the forecast over bigger interest rate hike than before is getting stronger.

The U.K. also suffering from an inflation rate of 9 percent level is also reviewing big step. Governor of Bank of England (BOE) Andrew Bailey commented during his speech on Tuesday “The 0.5 percent interest rate hike for the following month will be one of the options for the discussion.” If the U.K. drives up the interest rate by 0.5 percent it will be the first time since 1997, when the BOE decided the monetary policy on its own.

Although the interest rate hike in Europe and the U.K. may help suppressing the inflation from climbing up but may also worsen the already difficult economy. Europe was dealt a direct blow from the war in Ukraine and energy crisis, and countries in Southern Europe including Italy are exposed to high debt ratio as well as to political risks. As a result, concerns are being raised that a second round of the Southern European financial crisis could be repeated. Still the European stock market closed with sudden rise with the expectation that Euro value would recover from the rate hike.


Min-Woo Park minwoo@donga.com