Madis Müller: Inflation would only pick up pace without interest rates hike

Madis Müller.
Madis Müller. Source: ERR

Because the European Central Bank's decisions are based on the economic situation of the entire eurozone, Estonia needs to take other economic policy measures to contain its even faster than average price advance, Bank of Estonia head Madis Müller writes.

The Eurozone saw an increase in consumer prices of 8.1 percent in May, far beyond the European Central Bank's long-term goal of 2 percent. High energy prices are increasingly translating into price advance of other products and services.

Russia's aggression in Ukraine has caused the prices of food and other raw material for which Russia and Ukraine have been major suppliers to soar. The effects of the war and sanctions are further exacerbated by China's coronavirus restrictions. It is increasingly clear that we have cause to talk about more permanent price increase pressure in which situation the central bank must intervene.

Rapid inflation in the Eurozone, including Estonia, has not to any notable degree been caused by the ECB's extremely liberal policy of many years, despite opinions to the contrary.

The central bank's asset purchases or "printing" lasted for seven or eight years, while average price advance in the Eurozone was limited to 2 percent before the middle of last year. It would have been lower still had the ECB not taken this action to liven up the economy.

The effect of ECB quantitative easing has been limited, however, as much of the additional money did not reach companies and individuals. The banks were simply unable to find enough ways to lend out the money ECB asset purchases created.

Loan growth has rather remained modest in the Eurozone. In other words, the market did not see too much money that would have caused sharp price advance through major investments or growing expenses.

That said, the ECB would be to blame for potentially deepening price advance were we not to react to increasingly broad-based inflation. The full effects of central bank decisions on price advance will not manifest for a few years, which is all the more reason not to hesitate. This realization is behind the ECB's decisions from this week.

ECB additional asset purchases will be concluded from July 1. In addition, we have decided in principle to start hiking central bank interest rates in July. Financial markets have been anticipating this change for some time, which is why Euribor interest rates, usually referenced in loan contracts, have been growing recently. The six-month Euribor rate that affects most Estonian borrowers and has been negative since 2015 is above zero again from this week.

While the ECB decision to make people's home loans more expensive in a situation where rapid inflation is making life difficult for everyone might seem paradoxical, inflation would pick up even more speed without interest rate hikes, which would clearly be the worse development. It would be very difficult to rein in inflation were the central bank's credibility to suffer if we hesitated. It would require an even greater interest rates hike and possibly at the cost of recession.


Rapid inflation hits at everyone's income and savings, while least fortunate people stand to take the biggest hit. They spend much of their income on covering base needs and usually don't have real estate or other investments with the potential to retain their value. The European Central Bank aims its decisions solely at returning to inflation of roughly 2 percent in the coming years.

A look back in history suggests that Eurozone interest rates will remain very low in the Eurozone even after several consecutive hikes. Allow me to recall that the six-month Euribor rate, which we got used to staying negative, was on the other side of 5 percent in 2000 and 2008. That is why the Bank of Estonia has for years required commercial banks to sport a conservative home loans approach, meaning that the borrower's solvency needs to consider much higher potential interest rates.

In summary, it is clear that the central bank needs to play a part in bringing price advance under control for which we are prepared. Because the European Central Bank's decisions are based on the economic situation of the entire Eurozone, Estonia needs to take other economic policy measures to contain its even faster than average price advance. This means that Estonia needs to take care not to speed up price advance further through excessive spending and investments relying on loan money.

Least fortunate people who are affected the most by soaring energy and food prices need to be offered well-aimed help. Investments that could help permanently alleviate price pressure due to expensive energy need to be wisely chosen.

Going too far in offering people broad-based benefits and tax cuts could end up making the situation even worse, also for least fortunate people, should it add to inflation.


Follow ERR News on Facebook and Twitter and never miss an update!

Editor: Marcus Turovski

Hea lugeja, näeme et kasutate vanemat brauseri versiooni või vähelevinud brauserit.

Parema ja terviklikuma kasutajakogemuse tagamiseks soovitame alla laadida uusim versioon mõnest meie toetatud brauserist: