Interest rates: the three central banks facing one tricky balancing act
Whatever it takes. With those three words the then head of the European Central Bank quashed doubts in July 2012 about whether the euro had a future. Mario Draghi’s message to the financial markets was that they should not doubt his commitment to defend the single currency. The warning worked.
Ten years later, the ECB is again in the spotlight, but so are two other major central banks – the US Federal Reserve and the Bank of England. All three are facing the same problem: what to do about annual inflation rates that are nudging 10%.
A crucial month kicks off on Thursday when the ECB will raise interest rates for the first time in 11 years. With neat symmetry, Draghi is once again playing a pivotal role, this time by threatening to quit as Italy’s prime minister.
The prospect of the ECB toughening its stance had already alarmed the markets even before a political crisis in the eurozone’s third biggest economy loomed. Investors demanded a higher premium for financing Italy’s huge national debt so – in an echo of events in 2012 – the yield (or interest rate) on Italian bonds has risen. The gap – or spread – when comparing with German bond yields can be expected to widen further should Draghi resign.
This creates a dilemma for the ECB. On the one hand, it is committed to tackling inflation but on the other it wants to minimise the impact on Italy. “No matter if Italy goes into turmoil or not, the ECB will have to hike rates this week, and say that they will do more if needed in the coming meetings,” said Ipek Ozkardeskaya of Swissquote bank.
Christine Lagarde, Draghi’s successor as ECB president, said her team would come up with a new instrument to shield Italy from any adverse impact of higher rates, and the financial markets
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