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JUL. 22, 2022

The Way we Were

For the first time since 2011, the European Central Bank is raising interest rates. Things were very different in 2011. The President of the United States was Barack Obama. In Libya, Muammar Gaddafi was killed during the Arab Spring. The bitcoin reached the parity with the US$ for the first time since its creation in February of that year. Prince William and Kate Middleton got married, and just as the ECB was hiking, we were dancing to the notes of Party Rock Anthem.

Things were very different in Europe as well: the region was close to the peak of the European Sovereign Debt Crisis, and the term “spread” had become part of everyday conversations. The Sovereign Debt Crisis originated during the Great Recession, following the Global Financial Crisis. Portugal, Italy, Ireland, Greece, and Spain were the countries affected the most, and the crisis was threatening the very foundation of the European Union. In all of this, inflation was increasing above the long term 2% target, and the then President of the ECB, Jean-Claude Trichet, believed the most sensible answer to inflation worries was to increase interest rates.

The decision was however extremely ill timed: unemployment in the European Union was continuously increasing, and youth unemployment, in particular, was at an all-time-high. Economic growth in the region was slowing and various EU countries were already struggling to avoid defaulting on their debt: raising interest rates meant higher debt servicing costs for these peripheral countries and consequently higher default risk. The ECB was also the only bank to hike in 2011, the BOE and the FED left rates unchanged, as their economies were still too fragile, following the Global Financial Crisis.

The rate hikes did not create the EU problems, but certainly amplified them. Many countries were forced to take austerity measures, cutting government spending and raising taxes. This, in turn, had an additional negative effect on the region’s economic growth, fuelling a downward spiral. The austerity measures, at the same time, triggered social unrest: the existence of the European Union was under attack. A few months later the new President of the ECB, Mario Draghi, announced a U-turn on the Bank’s policies, with extraordinary measures of easing that provided relief on governments’ balance sheets and promoted financial stability in the Eurozone.

The situation is different nowadays in Europe: inflation is not a worst-case scenario, but a reality, at a print of 8.6% for the month of June. Unemployment is at the 20 year low. Growth, albeit not strong, is somehow there, and government balance sheets are no longer under pressure. Maybe this time the decision is well timed.

We are now waiting just for the BOJ to hike. A similar article will come, but I warn you already, the last time the BOJ hiked rates, the iPhone had not been released yet.

We thank you for your continued support.

The FAM team