Over the past 10 years, inflation in the EU has largely set below the ECB’s target of 2%, with the regular threat of deflation prompting the ECB to introduce negative interest rates in 2014 to help stabilise inflation close to their target. However, official interest rates at -0.5% seem incompatible with inflation soaring to all-time highs for the Eurozone. Pre- 2008, when inflation was stable at/ above 2%, the 2yr fixed rate set between 2.15% and 5.5% incongruous. Currently, it’s trading below zero.
As recently as 6 months ago, financial markets were pricing in no change in interest rates until June 2025. The market has now pulled forward the timing of an initial rate hike to this December even though the ECB position going into tomorrow’s meeting remains that rates won’t change in 2022. The ECB’s stance runs contrary to the position taken by the Bank of England who are expected to increase rates by 0.25% tomorrow and the USA’s Federal Reserve where the market chatter is around whether interest rates will need to rise by 0.50% instead of 0.25% at its next meeting in March. The ECB has argued that wage growth, a precondition of durable inflation, is still muted and underlying price growth is weak. However, with unemployment now running at a historic low of 7% and still falling, the risks are that wage inflation will increase as the labour market continues to tighten.