European Bank raises interest rates: will the BoE follow suit?

The European Central Bank has raised its interest rates for the first time in 11 years to 0%. What does this mean for the euro and European markets?

The ECB is the central bank for the euro and on Thursday announced that it would be increasing interest rates as a result of inflation for the first time in 11 years.

On its website, the body exclaimed: “When prices in our economy are rising too fast – that is, when inflation is too high – increasing interest rates helps us bring inflation back down to our 2% target over the medium term”.

The ECB raising interest rates has a varied impact. It makes it more expensive for banks to borrow money attracting people to save more and making loans higher for people and businesses — lowering demand for goods and services. It also moderates wage demand and keeps prices stopping wage-prices from spiraling. This will then have the desired impact of lowering inflation.

This interest rate impacts the entire economy including bank loans, market loans, mortgages and bank deposit rates.

The ECB’s president Christine Lagarde stated that the bank would be increasing its interest rates further over the coming months and also announced it would be introducing an anti-fragmentation tool called the transmission protection tool (TPI).

About TPI, the Bank said: “The TPI will be an addition to the governing council’s toolkit and can be activated to counter unwarranted, disorderly market dynamics that pose a serious threat to the transmission of monetary policy across the euro area.

“The scale of TPI purchases depends on the severity of the risks facing policy transmission…by safeguarding the transmission mechanism, the TPI will allow the governing council to more effectively deliver on its price stability mandate.”

What does this mean for the UK?

Some economists suggest that this move will encourage the Bank of England to raise its own interest rates. Since December, the BOC has increased the rate from 0.1% to 1.25%.

This follows the US Fed raising interest rates in a more extreme fashion by 0.75%. Comparatively, Canada raised its interest rates by one percentage point and Australia, New Zealand and South Korea have all raised interest rates by 0.5%.

According to the Office of National Statistics, the inflation reading in the UK for June is 9.4% — inflation was last this high in 1982.

The UK’s central bank has so far chosen smaller interest rate hikes, however the latest hike by the ECB has caused many to believe there will be further interest hikes in the UK.

Last Tuesday, at the annual Mansion House speech in London, Governor of the bank of England Andrew Bailey insinuated a possible 50 point interest hike –from 1.25% to 1.75% — in the coming month is a possibility.