July 18, 2022: The global surge in inflation has turned years of monetary policy on its head, with the European Central Bank set to raise its interest rates for the first time in over a decade.

The long-awaited move was preceded by the end of the ECB's crisis-era bond-buying programs that cradled the eurozone economy through deflation and the coronavirus pandemic.

Ahead of the ECB's historic meeting on Thursday, here's a look at the institution's response to testing times and the advent of a new and different crisis.

– Deflation and pandemic –

In 2014 with deflation looming, the ECB launched a bond-buying stimulus program to try to stoke prices and economic growth.

The tool worked by buying up bonds on the market and thus holding down borrowing costs for states, businesses, and consumers alike, who are then more likely to spend and invest.

With the ECB's interest rates already at historic lows, the programme has been the bank's main way of trying to provide stimulus for the economy.

The bank launched an additional asset-purchasing scheme in 2020 to keep borrowing costs under control and support the economy at the outbreak of the coronavirus pandemic.

Between them, both programmes have hoovered up trillions of euros in assets. Pandemic aside, growth in the eurozone improved, but inflation struggled to climb towards the ECB's target of two percent.

– What happened to inflation? –

While delivering a sharp shock to the economy, the pandemic set the wheels of inflation in motion. Scrambled supply chains led to increased costs, as did a resurgence in demand after the initial economic shock created by health restrictions.

Predictions that the pressure of the pandemic on prices would slowly fade were jettisoned when Russia invaded Ukraine on February 24.

The war has caused steep increases in the cost of energy, raw materials and food, with the eurozone feeling the brunt of the price pressures.

From a situation in which inflation was obstinately low, refusing to respond to ECB measures, outside forces are now keeping it persistently high.

Inflation in the eurozone reached 8.6 percent in June, the highest ever recorded for the currency club.

With the ECB pursuing the goal of keeping inflation at two percent over the medium term, the alarming figures have prompted a change of course.

– What is the ECB doing? –

The ECB ended its net asset purchases at the beginning of July. Interest rates — its main lever to control inflation — should start their upwards climb at the meeting on Thursday.

Currently, the ECB has negative rates of interest, a historically unusual set of circumstances.

ECB President Christine Lagarde wants to bring an end to those by the “end of September” and policymakers are urging the Frankfurt-based institution to make aggressive rate rises in the model of the US Federal Reserve.

But the war and an impending winter gas shortage have weakened the outlook for the economy, raising the prospect of a recession.

Raise rates too far and too fast and the ECB risks adding to the pain felt by the eurozone economy.

– What are the risks? –

Hanging over the decision are memories of the eurozone debt crisis when more indebted members came under intense strain as their borrowing costs soared.

Rising interest rates could see that pressure start to crank up again.

All eyes have been on heavily indebted Italy, whose borrowing costs have quickly ticked up, peaking after the ECB announced its plan to raise rates.

The ECB looks set to counter the risk of divergence between different members with a new tool, the first details of which could be announced on Thursday.

The ECB will hope it never has to put the new crisis-control instrument into practice, but its biggest test may yet lie ahead.

AFP/APP

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