This mistake with the interest rate will be felt hard in 2024

It is estimated that it will take about a year and a half for a central bank interest rate adjustment to become visible in the economy. There is a good chance that the interest rate hikes that the ECB is now implementing will seem less convenient in 2024 with retroactive effect.

This afternoon, Christine Lagarde, as President of the European Central Bank (ECB), announced that the policy rate will be raised by 50 basis points to 2,5%. In addition, she anticipated another rate hike at the next meeting on March 16. At first glance, there is little to argue with that decision. In January inflation in the eurozone was 8,5%. Although this is slightly lower than December's 9,2%, the current level is vastly above the ECB's target of just under 2%. Still, the question is whether the current policy still seems so smart when we look back on it in 2024 and 2025.

On the roadside or in the crash barrier
According to estimates by economists and central bankers, it could take 18 to 24 months for interest rate changes from the ECB to become visible in the real economy. The interest rate policy can therefore be compared to an attempt to keep the car on the road, while the wheels react to the steering movements with a delay of about ten seconds. Before you know it you are on the verge or you end up in the crash barrier. It could be that the ECB's current journey will also end in this way. Many things that fueled inflation last year – such as higher energy prices due to the war in Ukraine, supply chain problems and an expensive dollar – are now causing inflation to cool steadily.

What are wages doing?
For example, the price of a barrel of Brent oil is already more than 5% lower than the almost $ 90 twelve months ago. If nothing strange happens, that difference will become even greater in the near future. In March 2022, the oil price shot up to more than $120. However, the ECB has a greater eye for matters that structurally push up inflation, with wage developments at the top of the list. The strong wage demands of the trade unions indicate that the danger of a wage-price spiral cannot be ignored. However, the large rounds of layoffs at large technology companies indicate that the position of employees is not as strong as you might think.

A tug on interest rates
All in all, there is a good chance that the ECB will make a steering error with its current policy. Lagarde throws the steering wheel even further to the left, while a bend to the right is already visible a little further on. If the interest rate hikes in 2024 and 2025 are felt at a time when the European economy is already cooling down, it will be quite painful. Lagarde will probably see itself forced to give the interest rate steering too hard again. But for now, rising interest rates play a key role in currency markets. The prospect that the interest rate differential with the United States will increasingly close has translated into a gain of 2% for the euro against the dollar since the turn of the year.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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