The end of negative interest rates will not save Europe

Mario Draghi might have been credited with saving the euro, but Italian politics has proven too volatile for the technocratic central banker once dubbed “Super Mario”.

The 74-year-old was forced to resign, after less than two years as Italy’s prime minister. His national unity government collapsed following a walkout by Silvio Berlusconi’s Forza Italia party, and others.

Like many central banks, Christine Lagarde’s ECB may have waited too long to raise rates. Credit:Getty

Shares listed on Italy’s main stock exchange slumped in reaction, while the yield on the country’s 10-year bonds – which influence government borrowing costs – jumped to 3.6 per cent, the highest level since June.

The political crisis threatens to unleash a fresh phase of turmoil for the country’s debt and casts doubt over its budget and reforms needed to unlock €200 billion ($295 billion) in EU aid.

At more than 150 per cent of GDP, Italy’s debt is far larger than that of any other major economy in the currency area. Spain’s amounts to 118 per cent of its output and France is at 113 per cent. Germany is far less indebted at a mere 69 per cent.

Yet Italy still acts as a microcosm for the wider problems facing the eurozone. The energy crisis triggered by Vladimir Putin’s invasion of Ukraine has sent inflation soaring and the threat of recession looms large.

In an attempt to stem the tide, the European Central Bank (ECB) raised interest rates by half a percentage point – the first hike in more than a decade. It ended a prolonged period of negative rates, risking a eurozone catastrophe.

The central bank said rates would rise further in future meetings, adding: “The front-loading today of the exit from negative interest rates allows the governing council to make a transition to a meeting-by-meeting approach to interest rate decisions.”

But the ECB is a clear laggard in tightening its monetary policy and the end of its negative rates experiment – which experts predict might be finished for good – is unlikely to save Europe from recession. Some argue Christine Lagarde, the president of the ECB, is flirting with chaos.

Jim Reid of Deutsche Bank, said: “We can’t stress enough how abnormal these last eight years have been relative to history. Given the structural inflation forces were turning before Covid, and continue to point in that direction after it, it’s possible we won’t see negative rates again in Europe as far as the eye can see.”

The resignation of Italy’s PM Mario Draghi threatens to unleash a fresh phase of turmoil on the country’s struggling economy.Credit:AP

Many economists think the hike has come too late – the Bank of England first started tightening in December.

Hinesh Patel, at Quilter Investors, said: “[The ECB] has waited far too long relative to the Fed and the Bank of England, thereby creating additional pressure on the euro which is adding to inflationary pressure.”

He added that the stall in industrial activity across the eurozone indicates this rate hike is likely to have minimal impact. “The bloc is faced with inflationary shock combined with ongoing uncertainty driven by the war in Ukraine, but the ECB’s previous inaction means today’s rate hike could well be too little too late.”

Hiking interest rates will also do little to help Europe’s deepening energy crisis. On Wednesday, the European Union’s executive body urged member states to slash their gas consumption by 15 per cent, as it warned a complete shutdown of Russian supplies was “likely”.

While it might have been a milestone, reversing the eurozone’s eight years of negative rates is unlikely to alleviate fears that the bloc is heading into another crisis.

Ursula von der Leyen, president of the European Commission, said: “Russia is blackmailing us, Russia is using energy as a weapon.

“It is a likely scenario that there is a full cut-off of Russian gas and that would hit the whole European Union. A gas crisis in the single market, our economic powerhouse, will affect every single member state.”

Without Russian gas, experts predict the bloc is unlikely to have enough supply to warm homes and keep the lights on throughout the winter.

ECB officials also agreed to a new bond-buying programme yesterday – the Transmission Protection Instrument (TPI) – aimed at capping the rise in borrowing costs for the bloc’s more vulnerable governments.

“The ECB is capable of going big,” Christine Lagarde said, before adding: “We would rather not use [the new programme], but if we have to use it, we will not hesitate.”

Europe’s reliance on Russian gas has raised the prospect of a bleak winter as the energy crisis deepens.Credit:AP

Countries will be eligible only if they comply with EU’s fiscal rules and do not face “severe macroeconomic imbalances”.

The policies, however, do not emulate Draghi’s “whatever it takes” and the creation of an emergency bond purchase scheme in 2012, which were widely considered to have saved the euro during the height of the eurozone’s last debt crisis.

The currency erased earlier gains as traders hit out at Lagarde for a lack of detail on rates, as well as growing doubts over the bond-buying scheme.

Kaspar Hense, at Bluebay Asset Management, said: “The market is trying to force Lagarde into giving clear guidance on when they will use the tool and a stronger ‘whatever it takes’ commitment, whereas Lagarde still does not want to give too much away.”

Nick Chatters, at Aegon Asset Management, said the TPI programme “looks cosmetically quite weak, not least as it relies on the governing council to all subjectively agree, if they are going to buy Italian bonds”.

While it might have been a milestone, reversing the eurozone’s eight years of negative rates is unlikely to alleviate fears that the bloc is heading into another crisis.

Aegon’s Chatters says: “We all miss Draghi’s firm hand on a day like this.”

Telegraph, London

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