The European Central Bank’s decision to raise interest rates by 50 basis points was widely expected. Not even the turmoil in the banking sector could dissuade the ECB council from going ahead with the rate hike, the sixth time it has done so.
It has raised its deposit rate to 3 per cent, the highest level since 2008 for the 20 countries in the euro zone with the aim of reining in inflation, considered a major threat to their economies which had enjoyed an extended period of price stability. For close to 15 years we lived through times of extremely low interest rates and inflation rates below 2 per cent, but this could not last.
The quantitative easing during the years of the pandemic, inevitably, pushed up prices, which were rising long before Russia’s invasion of Ukraine. The war which caused turmoil in energy markets increasing gas and oil prices made the situation worse. Inflation, which was close to 10 per cent last year is forecasted to average at 5.3 per cent this year and 2.9 per cent in 2024. In 2025 it is forecasted to be 2.1 per cent, still higher than the ECB’s 2 per cent price growth target.
The higher cost of borrowing will affect business investment and consumer spending and, in theory, encourage more savings. This, however, is questionable given that banks are still not offering very attractive rates on deposits. Despite the higher interest rates the euro zone still expects a growth rate of 0.9 per cent this year, rising to 1.5 per cent in 2024, projections that indicate the fight against inflation will not lead to recession.
For Cyprus, forecasts are better than those for the euro zone, with GDP growth expected to be 1.6 per cent this year, significantly lower than the impressive 5.8 per cent of 2022 but the rate of inflation will be halved, falling to 4 per cent, lower than the euro zone average. Of course, there are still complaints about the rising interest rates which affect loan repayments, while some populist politicians have gone as far as to suggest that banks avoid raising the interest rates.
Perhaps this because businesses and individuals had become accustomed to the extremely low interest rates of the last 15 years, which should always have been seen as the exception rather then the rule. In fact, the extended period of cheap money created many market distortions which the rising interest rates, aimed at fighting inflation will eventually iron out. It will be a difficult time for businesses as well as for individuals, but inflation, which negatively impacts people’s living standards must be brought under control. There is no other way of protecting living standards in the medium term.