What are the repercussions of the dramatic rise in interest rates in the European Union?

In January of last year, Christine Lagarde said a raise this year was « extremely unlikely. » However, this did not take into account the ongoing conflict in Ukraine. After increasing interest rates for the first time in ten years by 50 basis points in July, the European Central Bank (ECB) stated on Thursday, September 7th, that they would be increasing them once again by 0.75 basis points.

The struggle against inflation, which has not yet been won despite the fact that it is still on the ascent, will have significant repercussions, both for the production of businesses and for the market. The value of the euro against the dollar has never  been lower in the last 20 years due to the Federal Reserve increasing its interest rates in a more radical manner.

In practical terms, an increase in rates that are imposed by the Central Bank results in an increase in the interest rates of commercial banks. It is thereby getting more expensive to incur debt, whether for individuals, organizations, or governments. This applies to all three types of borrowers. As a direct consequence of this, demand is falling, which is unfavourable news for businesses.

For example, the interest rates that banks are willing to offer for the acquisition of real estate are going to be far higher than they are typically. This should lead to a decrease in the number of purchases and sales, but it should also lead to a decrease in the price of real estate in the years to come.

When it comes to the government sector, the rise in key interest rates will result in higher interest rates being applied to the debt of member states of the European Union. As a result, the cost of making debt repayments will rise, which may place certain nations in a tough financial position.

The decline in interest rates will, on the bright side, provide banks more leeway to move, since they should be able to offer more appealing returns on some assets as a result of this newfound flexibility. On August 1st, as a consequence, the rate of the Livret A in France was increased by 100%.

But if the European Central Bank (ECB) has decided to gradually raise key interest rates, it is because they want to ensure that the post-Covid-19 economic recovery is not derailed. As a matter of fact, Europe is at risk of going into a period of recession as a direct consequence of the decrease in spending and, as a result, overall growth.