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Global Economy

ECB increases key interest rate to 0.5 percent

In view of the significantly higher inflation rate, the European Central Bank (ECB) has now reacted and raised the key interest rate for the euro zone for the first time since 2011. The monetary authorities around ECB boss Christine Lagarde decided to increase the so-called main refinancing rate by half a point to 0.5 percent. This interest rate applies when commercial banks borrow money from the central bank for a longer period of time. The so-called deposit rate was also raised, from minus 0.5 percent to 0.0 percent. Banks no longer have to pay extra if they park excess money overnight at the ECB.

The ECB's turnaround is historic: it follows an era of ultra-loose monetary policy. However, the record inflation in the euro area has now prompted the central bank to undertake unusually strong tightening maneuvers: for the first time since 2000, the monetary watchdogs have raised key interest rates by 0.5 percentage points. In its previous meeting, the ECB had only announced an increase of 0.25 percentage points. However, in the past few days, this has often been considered insufficient in view of the record inflation of 8.6 percent in the euro zone.

"The Governing Council of the ECB came to the conclusion that a larger first step in its interest rate normalization than that signaled at its last meeting is appropriate," the central bank said after its decision. At the same time, she made it clear that further interest rate hikes will follow in the coming months. Further normalization of interest rates would be appropriate at the upcoming meetings. The Governing Council would move to an approach where interest rate decisions would be taken on a per-meeting basis. "The Governing Council's future key interest rate path will remain data-driven and will contribute to the Governing Council's medium-term inflation target of 2%."

New anti-crisis program

Accompanying the turnaround in interest rates, the monetary watchdogs have agreed on a new crisis program called the "Transmission Protection Instrument" (TPI). According to Lagarde, the aim of the program is to be able to support states in the event of turbulence on the financial markets.

It was created for special situations and risks that could affect any state. This means that every country in the euro zone should also be able to benefit from the program. The ECB wants to counteract "unjustified, disorderly market dynamics" that pose a serious threat to the effectiveness of monetary policy in the euro area. If necessary, the Governing Council will decide whether this program will be activated for a country. The monetary authorities would use a number of indicators as criteria. Lagarde stressed that the Governing Council would decide for itself.

As part of the TPI program, the ECB intends to intervene by buying government bonds if necessary, should interest rates on securities in a euro country soar disproportionately due to financial speculation. TPI will thus ensure "that our monetary policy course is transferred smoothly to all countries in the euro area," said Lagarde. The ECB would rather not use TPI, she assured. "But if we have to use it, we won't hesitate."

Possible needs of Italy not yet an issue

The yields on the government bonds of the euro countries had risen in the course of the expected turnaround in interest rates in the past few months. Because with the move away from the ultra-loose monetary policy, investors are once again looking more closely at the different risks when they buy bonds from a specific country.

The yields of heavily indebted euro countries such as Italy have recently risen particularly sharply. At times, the yield spreads between the government bonds of various euro countries had risen so sharply that fears arose that a new euro crisis might loom. Because with the increase in yields, the financing costs increase for the countries.

With a view to current developments in Italy after the resignation of Prime Minister Mario Draghi, Lagarde declined to comment. "The ECB does not take a position on political matters," she said. However, when asked about possible support for Italy through the new TPI program, Lagarde said: The Governing Council will carefully assess whether a country can participate in the TPI when the time comes. According to the ECB, part of the conditions for participation in the TPI program is a solid and sustainable economic policy.

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