Europe makes the price of money more expensive

In Europe, families are once again trembling in the face of the scenario of interest rate increases that the respective central banks are proposing as a gradual strategy to contain the inflation balloon and prevent it from turning into stagflation for several countries.

On 15 June, the US Federal Reserve moved its interest rate by 0.75 points, between 1.5 and 1.75%, the largest increase in the last three decades.

The Fed was followed by the Swiss central bank moving its rates from -0.75 to -0.25%; it has not raised them for 15 years, although they are still negative. The Bank of England also broke its sluggishness and increased its rate to 1.25%.

On Thursday 21 July it was the turn of the European Central Bank (ECB) to make its move with a rate hike that its head Christine Lagarde has taken as a litmus test for her administration.

Goodbye to the long years of lax monetary policy to boost the economic recovery hit by the subprime crisis; this oxygen balloon through low rates - in many cases at zero levels and in others in negative territory - allowed the purchasing power of companies, individuals and families to have a little breathing space in financing. 

This cycle is over: paying in easy monthly instalments will once again become a nightmare because the ECB has decided to break with 11 years of not raising rates and has readjusted interest rates by 50 basis points; this is the biggest upward adjustment in the last twenty-two years, in fact, it was even speculated that the rise would only be 0.25 basis points. 

Lagarde has not ruled out that this is the beginning of a race to raise rates until the inflation beast, which in June rose to 8.6% in the Eurozone, is tamed. In Spain alone, the CPI rose to 10.20% a year, the highest inflation in 37 years.

Rising interest rates are not good news, it means that financing will become more and more expensive and it will be worse for individuals and families with variable credits, mainly mortgages. 

It is certainly not an easy decision, nor a popular one, and each economy will suffer the effects of resorting to a restrictive monetary policy depending on the level of indebtedness of companies, individuals, families and, of course, also public administration and local governments, from town councils to the largest government bodies. Virtually no one will be left unscathed. 

Higher rates make credit more expensive, debt more expensive, debt repayments more expensive and affect both internal and external debt. There are several countries with quite disturbing levels of public debt as a percentage of GDP. For example, in Spain, its debt last March rose to 1.453 trillion euros, it has a ratio of 117.7% as a percentage of GDP and not all of it is the result of the imbalance between revenues and expenditures, there are also loans and financing acquired as obligations to be paid.

We will have to keep a close eye on the banks' accounts and watch their default rate, which is always affected in one way or another when interest rates rise. Money lent will be more expensive but wages and salaries will remain ceteris paribus. Defaults tend to be just around the corner, so the huge challenge for central banks is to control inflation, without contributing to further financial failures in the future. 

Last April's forecast by the International Monetary Fund (IMF) projected global average inflation of 7.4% by 2022. Emerging countries were then the hardest hit with an average inflation rate of 8.7%.

At the end of the first half of the year, the World Bank in its Economic Outlook has begun to warn of the "risk of stagflation" with "potentially damaging" consequences for both middle-income and low-income economies. Global GDP is estimated at 2.9% for this year, the forecast in January was 4.1%.

Stagflation would be an undesirable scenario because economic stagnation is usually accompanied by rising unemployment and higher inflation. It means burning money... burning purchasing power.

Why do central banks raise rates in inflationary times? To cool consumption. The intention is to take money out of circulation because people prefer to invest it and deposit it in financial institutions because of the incentive of receiving an attractive interest rate and that in the end contributes to less inflation. We will see at what cost...