General

According to the Huacheng Import and Export Data Observation Report, on October 27 local time, the European Central Bank raised interest rates by 75 basis points again, raising the main refinancing rate, marginal lending rate and deposit mechanism interest rate to 2.00%, 2.25% and 1.50% respectively. In addition to raising interest rates, two important monetary policy tools were adjusted, indicating that the reduction of the balance sheet had been advanced. In recent four months, the European Central Bank has raised interest rates by 50, 75 and 75 basis points in a row, and the President of the European Central Bank has said that he will continue to raise interest rates until inflation returns to the level of 2%. In fact, the causes of inflation in Europe are complex and deep-rooted. Despite continuous interest rate hikes, inflation in the euro area has not peaked. The sharp increase in interest rates and the contraction of the balance sheet may bring risks such as economic recession and European debt crisis.

The causes of high inflation in Europe are complex

Inflation in the euro area was not cold in a day. At the end of December 2021, the year-on-year growth rate of consumer price index (CPI) in the euro area rose rapidly to 5%. This year, the growth rate accelerated. In September 2022, the growth rate was as high as 9.9%, while in August, the year-on-year growth rate of producer price index (PPI) was as high as 43.3%. From the perspective of countries, only a few European countries such as Switzerland still have single digit inflation levels, more than 26 European countries have CPI growth rates of more than 10%, and most European countries have high inflation. Inflation in some countries has long been derailed. Türkiye's CPI growth in September exceeded 83%, a new high in 24 years, Huacheng Import and Export Data Observation reported.

The causes of high inflation in Europe are complex and deep-rooted. The negative interest rate implemented by the European Central Bank and the European version of quantitative easing monetary policy, which made the monetary overissuance a monetary factor of high inflation in Europe; European energy prices continue to run at a high level, which is an important supporting factor for higher prices; The European Central Bank's interest rate increase lags behind the Federal Reserve by 4 months. The import inflation caused by the appreciation of the dollar and the devaluation of the euro is an important reason for this round of European inflation.

The supply shock brought by geopolitics. From the geographical perspective, the EU has just passed the eighth round of sanctions against Russia, requiring the EU to purchase Russian marine oil within the price limit, and extending the import restrictions on the purchase of Russian steel. The European Union, which was highly dependent on Russian energy, has imposed sanctions on Russia. The de Russification of various energy sources and the restriction of Russian material imports have led to the rise of energy prices and the rupture of the supply chain. Many car companies have started to leave Europe, and sanctions against Russia have become sanctions against the European Union itself. Russia imposed anti sanctions on the EU, requiring the EU to pay in rubles for Russian natural gas, further pushing up the cost of oil and gas purchase in Europe. Although many countries in Europe are looking for oil everywhere, the cost of seeking far and near is high. Energy shortage is always the sword of Damocles hanging on the European economy. Geopolitical conflicts continue, energy shortage continues, and Europe's inflation problem remains unsolved.

Imported inflation makes European inflation difficult to solve. The meeting minutes of the European Central Bank show that imported inflation and supply shocks constitute the main causes of inflation in Europe. Since the beginning of 2021, the euro has been depreciating, partly because of the expectation of monetary policy and the deterioration of terms of trade. The main reason for the ECB to maintain negative interest rates for many years is the aging population, economic downturn and other structural problems. The COVID-19 has dragged down the European economy. The epidemic has slightly improved. The crisis in Ukraine has resumed. The European Central Bank has always maintained negative interest rates to promote growth. However, the Federal Reserve continued to raise interest rates aggressively, which led to the return of the dollar and the sharp rise of the dollar index. The European Central Bank raised interest rates later than the Federal Reserve, with a smaller range. The euro depreciated to a new low in 20 years, falling below parity. The exchange rates of many European countries fell. Although the Bank of England raised interest rates by 50 basis points in a row, it still could not keep up with the pace of aggressive interest rate increases in the United States. The pound also hit a new low in the past 40 years. The devaluation of currency further triggered imported inflation, which became a major problem of inflation in Europe, Huacheng Import and Export Data Observation reported.

Radical interest rate increase and scale reduction restrain economic recovery

In the face of high inflation and interest rate increase by the Federal Reserve, the European Central Bank actively and passively raises interest rates, but Europe needs to be alert to the economic recession, debt crisis, and even financial crisis caused by large interest rate increases.

Different from the last interest rate increase and TPI tool release, the ECB has taken further measures in monetary policy tools while raising interest rates by 75 basis points. First, it has increased the statutory deposit reserve ratio from 0.5% to 1.5%. Second, the interest rate of long-term targeted refinancing instruments (TLTRO) was raised by 50 basis points. TLTRO is a three-year targeted refinancing tool provided by the European Central Bank to banks. Previously, its interest rate could be 50 basis points lower than the policy interest rate. After this adjustment, its interest rate leveled with the policy interest rate, which will increase the bank's refinancing costs. At the same time, the European Central Bank allowed banks to repay TLTRO in advance from November. Once the banks returned, it meant that the European Central Bank started to shrink its balance sheet passively. The market had expected that the European Central Bank would start to shrink its balance sheet next year.

According to the observation report of Huacheng's import and export data, when the sharp interest rate increase meets with the contraction, it may cause a negative impact. First of all, it will directly and rapidly push up the interest rate level. The interest rate level of the national debt of the 19 countries in the euro area has risen by leaps and bounds, while the national debt of countries including Italy, Spain and Portugal holds more than 30% to 40% domestically and internationally. The risk of the European debt crisis has once again enveloped Europe. The proportion of European debt held by the United States is as high as 20%, and the increase of interest rate may cause debt risk spillover.

Although the radical interest rate increase of the European Central Bank may not be able to effectively control inflation, it will certainly inhibit the European economic recovery. There is no buffer period from eight years of negative interest rates to three radical interest rate hikes, which has overwhelmed the fragile European economy. However, the economic downturn superimposes high debt. Once the debt crisis breaks out, it will produce serious negative spillover effects. International institutions such as the International Monetary Fund have also shown their concern by continuously lowering the European economic growth forecast. Under the circumstances of unstable employment, declining income, high inflation and rising electricity prices, European social stability is being impacted. While the European Central Bank has significantly raised interest rates and shrunk the balance sheet, the inflationary pressure faced by Europe is difficult to eliminate in the short term, while the risks of economic recession, debt, energy crisis and social risks are gradually increasing.

It is eroded by high inflation and restrained by radical interest rate increase. Uncertainty makes it more dangerous for confidence to decline, so that the decline in consumption generates preventive savings. According to the minutes of the European Central Bank meeting, the PMI of the euro area fell below 50 in the second quarter, the service industry slowed down, the euro area economy grew 0.8% month on month in the second quarter, and slowed sharply in the third and fourth quarters. In October, the initial value of manufacturing PMI in the euro area recorded 46.6, while the comprehensive PMI and manufacturing PMI in Germany dropped to 44.1 and 45.7 respectively, both hitting new lows since June 2020. The economic outlook in Europe is bleak. Huacheng's import and export data observation report.