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‘Impossible Situation’: Europe Faces Recession, Debt Crisis As Rate Hike Looms

The European Central Bank (ECB) will announce its first interest rate hike in over ten years on Thursday, and economists say that ECB President Christine Lagarde has to weigh possibly provoking a debt crisis and recession against bringing runaway inflation under control.

Inflation in Europe jumped to 8.6% in June, prompting calls for interest rate hikes that economists hope will bring rising prices under control. Stronger economies in the eurozone want aggressive rate hikes since inflation is their top concern, but weaker economies that have a lot of debt that would become more expensive if rates went up oppose this, highlighting the difficulties of having the same macroeconomic policies govern the economies of many different countries, the Financial Times reported.

The European Central Bank is different from the U.S. Federal Reserve because it manages monetary policy across a number of different countries. While combatting inflation by raising interest rates is a top priority for stronger European economies like France and Germany, others with higher levels of debt could be plunged into crisis if rates go up, E.J. Antoni, research fellow for regional economics at the Heritage Foundation, told the Daily Caller News Foundation.

“Countries that are heavily in debt and have a higher debt-to-GDP ratio get really hurt when rates go up. These countries are often just paying off the interest on their debt on a monthly basis, and so when interest rates go up their monthly payments go up, but they’re not even making a dent in the actual debt they owe, just paying more and more to service it,” Antoni told the DCNF.

Also complicating the ECB’s deliberations is an energy crisis in Europe due to Russia’s invasion of Ukraine that could be leading the bloc into a recession. Raising interest rates would exacerbate that as well, the FT reported.

But at the same time, some Baltic countries are seeing price increases upwards of 20%, prompting one ECB council member to condemn the ECB for not acting fast enough to raise rates and tackle inflation.

“Interest rates are our medicine and the timing and size of the dosage are of utmost importance,” the anonymous council member reportedly said.

Europe is left, then, needing to raise interest rates to prevent rampant and damaging inflation, but doing so could both kneecap indebted economies like Greece, Italy, Portugal and Spain, and even plunge the whole eurozone into recession if energy supply disruptions are not resolved.

“It is an almost impossible situation,” Maria Demertzis, deputy head of the Brussels-based Bruegel think tank, said to FT.

The ECB has been far more conservative in raising rates than central banks of other advanced economies thus far, and the rate hike announced Thursday will likely be either 0.25% or 0.5%, up from the current rate of negative 0.5%, an all-time low, according to The Wall Street Journal.

The Fed has set rates in the U.S. between 2.25% and 2.5% and is likely to raise them by another 0.75% this month, while Canada’s central bank raised rates last week by 1% to 2.5%, the WSJ reported.

This wariness to bump rates up has caused the Euro fall to a 20-year low and achieve parity with the dollar last week.

The ECB did not immediately respond to the DCNF’s request for comment.

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