Europe’s had 8 years of negative interest rates and paltry growth. Now it’s being forced to raise rates—and there’s still no growth

In the throes of the euro debt crisis in June 2014, the Mario Draghi-led European Central Bank instituted a historic policy of slashing interest rates below zero in the hopes of spurring economic growth, catalyzing business investment, boosting the labor market and throwing a lifeline to the weaker economies in Southern Europe.

The move was not without controversy. Going negative effectively punished savers—their deposits no longer yielded any kind of return—and it clobbered banks.

Bank bosses likened it to kryptonite as they watched their net-interest income decline quarter by quarter, and saw their share prices enter a similar spiral. “In the long run, negative rates ruin the financial system,” Deutsche Bank CEO Christian Sewing grumbled at a banking conference in Frankfurt, the hometown of the ECB.

Spoiler: Negative rates didn’t exactly work as advertised for the wider euro area economy either. GDP growth across the 19 countries that use the euro rebounded in 2015, but not to any meaningful level, stubbornly sticking around 2% per year, on average, before COVID-19 socked it for a hefty loss.

View this interactive chart on Fortune.com

Now, after eight years of negative rates, the ECB is changing tack. This summer, the ECB will close the door on super-loose monetary policy and begin to tighten—at first it will halt its bond-buying program, and then raise rates, it’s expected to reveal in a Thursday press conference in Frankfurt. However, some of the details for how the central bank will reverse course were revealed in ECB president Christine Lagarde’s May 23 blog post.

“In the end,” Lagarde wrote, “we have one important guidepost for our policy: to deliver 2% inflation over the medium term. And we will take whatever steps are needed to do so.”

Lagarde’s “whatever steps” vow is designed to minimize the damaging effects of one major risk to the euro area: inflation, which is running at a red-hot 8.1%.

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But there’s a big danger in doing so. Dovish critics fear that tightening now—as the continent stares down Russia’s war in Ukraine, an energy and food crisis, and supply chain shocks—could do more harm than good for the world’s No. 3 economy.

And so all eyes will be on Lagarde on Thursday as she’s expected to give further details on how exactly the ECB will put the brakes on rising inflation, and somehow manage to avoid any major economic fallout.

The S-word

“The ECB has so far rejected the term ‘stagflation’ to describe the current situation and the near-term outlook for the Eurozone economy,” Holger Schmieding, chief economist at Berenberg Bank, noted in a research report this week. “We expect the ECB to still shun this term on Thursday.”

But just because they’re avoiding the S-word doesn’t make the problem any less real. Schmieding is among a growing number of economists who believe inflation hasn’t yet peaked in Europe, and that growth is in serious jeopardy. Berenberg predicts euro area inflation will tick up to 8.5% by September. And, it just revised lower its full-year 2022 forecast of real GDP growth for the region from 2.7% to 2.5%.

With such growth risks looming, it’s clear why the ECB’s path to tightening looks fairly wimpy compared to the ultra-hawkish approach in play across the Atlantic at the Federal Reserve. So far this year, the Fed has raised rates twice—including a 50-basis-point hike in May—with several more forecasted into next year to bring the benchmark rate to above 3% by early 2023.

In contrast, economists see Lagarde & Co. moving at a deliberate pace. BofA Securities, for example, sees a total of 150 basis points worth of hikes to bring the main lending rate from -0.5% currently to 1.0% by end-of-year. Further out, Goldman Sachs sees the ECB not topping 1.5% by mid-2023. There’s a big asterisk on that forecast, however. “A full shutoff of Russian gas or significant sovereign stress could prompt the [ECB] governing council to pause,” says Jan Hatzius, Goldman’s chief economist.

Impact on the markets

The FX and stock markets have already begun to price in such a significant policy shift by the ECB. The euro has appreciated by more than 1% versus the dollar since Lagarde’s blog post was published two weeks ago, putting a floor on a significant months-long slide.

The area to watch, however, is bonds, which are highly sensitive to big pivots by central banks. In recent weeks, there’s been a big flight from European debt.

As Deutsche Bank noted, the yields on the German 10-year bunds—considered more desirable and stable than, say, Italian sovereign debt—hit an eight-year high on Monday, suggesting the already-weak demand for European debt is faltering. (For bonds, yields move inversely with prices; falling prices equate to higher yields.)

That price action is playing to fears the ECB’s dramatic about-face could trigger fresh doubts about the finances of the euro area’s weaker members.

As Berenberg’s Schmieding explains, “the end of net asset purchases”—which includes bonds issued by the likes of Italy, Spain and Greece—”adds to the risk that yield spreads may widen more than the majority of ECB council members would like to tolerate.”

Going negative may have been the easy part. What comes next is anybody’s guess.

This story was originally featured on Fortune.com