The Governing Council of the European Central Bank (ECB) meets seven times a year in Frankfurt, but once a year it travels to one of the eurozone countries (in June 2018, the ECB management visited Latvia). After a 15-year break, this year it was time to head to Greece again, and the outcome of the meeting was quite symbolic - interest rates were not raised for the first time since last July. Greece is the eurozone country with the highest debt-to-GDP ratio (173%). When interest rates rise, the cost of servicing public debt increases very rapidly.
Therefore, such a decision by the ECB is not only a relief for the people of the eurozone countries that have borrowings but also for all the governments of the eurozone countries that will sooner or later have to refinance EUR 13.2 trillion in the coming years. Only time will tell whether this is a pause or a signal that the times of rising interest rates have come to an end. This is why I have named the decision not to change interest rates this time as the “Athens gambit”, which means that the central bank is “keeping all doors open”, regardless of the negative impact of high interest rates on lending indicators. (One should not expect a rate cut in the coming months).
According to the ECB, “inflation is still expected to remain too high for too long and strong domestic price pressures persist”. The assessment expressed at the last meeting was also maintained: "The Council considers that the key ECB interest rates are at a level which, if maintained for a sufficiently long period, will contribute significantly to the achievement of this objective (inflation returning to its medium-term target level of 2%)."
Interest rates have reached a plateau
While you might breathe a sigh of relief, there is no 100% guarantee that euro interest rates have not peaked in this growth cycle. Unexpected events that might alter inflationary trends could result in another rate increase.
Based on the ECB’s assessment of inflation, economic growth, and lending in the eurozone, the risk of an interest rate increase is very low. Anyhow, it currently appears that a significant cash reserve would not be required for a future rate increase.
On 26 October, the 1-year Euribor rate was 4.128%, the 6-month Euribor rate was 4.105% and the 3-month rate was 3.952%. The clustering of interest rates close to the ECB deposit rate, the 4% mark, indicates that financial market participants (who tend to be quite wrong on average) do not expect any further increases in euro interest rates.
Given the risks to economic growth, everyone is rather awaiting the date of the first interest rate cut. There was no comment from the ECB’s management at this meeting since the prevailing mood at the moment is to maintain interest rates at their current level until the inflation data forces them to change their actions. With today’s ECB decision, we appear to have reached a plateau in interest rates, and the question is rather how long this plateau will persist.
It is somewhat concerning that this week’s US GDP data came in much better than expected by the market (+4.9% in the third quarter), which suggests that despite high interest rates, the world’s leading economy is still in good shape.
Deposits of Latvian residents in Latvian banks are decreasing
It is the first time in more than a decade that household deposits in Latvian banks have decreased during the year. There has been a decline of 0.48% in household deposits in September compared to September last year. High interest rates, previously high inflation, and weak lending will most likely negatively impact Latvia’s economy in the near future. Here, I will refrain from commenting on what is happening on the Latvian political scene regarding the price of money.
US FRS will meet from 31 October to 1 November, while ECB leadership will have a meeting in Frankfurt on 14 December.
