The ECB takes a beating - Economic Policy

The ECB takes a beating – Economic Policy

The European Central Bank announced a series of rate hikes to bring inflation down. But as the European economy verges on recession, the decision is open to criticism.

The European Central Bank (ECB) does not always have a sense of timing. It had raised its rates in July 2008, a few weeks before the start of the great financial crisis. It had also increased them in 2011, in the midst of the eurozone crisis and on the eve of a stock market crash. And now it is raising its rates again as Europe is expected to plunge into recession. Some facetious bankers have even drawn an adage from it: “rates rise in the summer, disaster in the fall”…

The European Central Bank (ECB) does not always have a sense of timing. It had raised its rates in July 2008, a few weeks before the start of the great financial crisis. It had also increased them in 2011, in the midst of the eurozone crisis and on the eve of a stock market crash. And now it is raising its rates again as Europe is expected to plunge into recession. Some facetious bankers have even drawn an adage from it: “rates rise in the summer, disaster in the fall”… And it’s true, rarely has a monetary policy decision sparked as much heated debate as the rise, decided here few days, European key rates. Former ECB Vice-President Vitor Constâncio is among those unhappy. In a very noticeable tweet, he aligns his former colleagues: “The ECB opted for a 75 basis point hike. I was more for 50 points. This difference does not matter so much. worrying is what has been announced, what this may mean for the rest of the cycle and what this means for monetary policy”. The economist is not the only one to think that raising rates and above all announcing other increases on the eve of a recession is not a good idea. World Bank President David Malpass followed suit a few days ago, saying that rather than shutting down economic activity to fight inflation, policymakers and monetary policy makers should instead take steps to foster growth. investment and productivity gains. The origin of the debate is therefore the decision of 8 September, when the ECB raised its key rates by 75 basis points. It raised the rate of its main refinancing tool from 0.50 to 1.25%. But above all, Christine Lagarde, the president of the institution, insisted that this increase “was not an isolated decision. We will continue to increase the rates. We will determine, meeting after meeting, on the basis of data, how reach the level of interest rates that will allow us to return to our inflation target of 2% in the medium term”. Because for the ECB, inflation is far too high. It indeed reached 9.1% in August in the euro zone. The institution’s economists are now counting on average inflation of 8.1% for this year as a whole, 5.5% next year and 2.3% in 2024. We are therefore far from the objective of 2%. Read also | Has the ECB gone blind? Everyone agrees: Today’s price hike is the result of the chaotic post-covid reboot of the global economy, the effects of lockdown still being felt in China and , of course, from soaring energy prices linked to the war in Ukraine. The ECB is well aware that the root cause of inflation is to be found on the supply side, that is to say companies which offer goods and services and which are forced to raise their prices not because that demand is exploding but because the supply of raw materials, certain components, transport, energy, is becoming scarce. But Christine Lagarde thinks she still has a lever to pull. “We have a good analysis of the breakdown of the sources of inflation, where it really is and which products are affected, she notes. Energy remains the major source of this inflation. But we also have inflation which spreads to a whole series of products and in particular in services where the supply factor is less prevalent and where demand plays a role. It is on this inflation, stimulated by demand, that the ECB wants to influence by using the weapon of interest rates. “The ECB’s discourse is completely coherent, observes Philippe Ledent, senior economist at ING and teacher at UNamur and UCLouvain. Indeed, we cannot say that all inflation is imported. There is another part on which we can act. We cannot have a phenomenon where everyone constantly transfers the increase in costs to the other. To bring inflation down, there is a time when an economic actor must take the loss related to the inflationary shock.” Otherwise, we find ourselves in the nightmare of the 1970s, with households asking for wage increases, which increases the production costs of companies which raise their prices, which weakens the purchasing power of households, who demand a new rise in wages… And in the end, companies become so uncompetitive that they relocate (those that can in any case), resulting in soaring unemployment. To put an end to this infernal spiral, someone must indeed take his loss: either households by reducing their purchasing power, or companies by cutting back on their margins. The economic scenario on which we base ourselves is very important. The ECB is indeed forecasting, in its “base scenario”, growth of 3.1% this year, 0.9% next year and 1.9% in 2024. In other words, activity, despite shocks, will continue to progress. “As the ECB is not expecting a recession, it is normal for it to increase its rates, adds Philippe Ledent. There is a slowdown, but people will dip into their savings to compensate for the loss of purchasing power. and the reopening of certain sectors of the economy will cause people to consume more. I hope the ECB is right.” But the economist has doubts: the research services of ING are much more pessimistic and believe that the euro zone will be in recession (-0.6%) next year. In such a context, tightening rates even further “will only make things worse”. Many are of this opinion. “We are not in inflation due to an increase in demand, explains Eric Dor, director of economic studies at the IESEG School of Management. And the rise in rates will not encourage Vladimir Putin to be more complacent to our The effectiveness of such a monetary policy is doubtful. Inflation is naturally causing a fall in demand. Today, already, consumers are seeing their purchasing power fall and are consuming less. And many companies are in the red and are no longer investing. There was no real need for a rate hike.” Unless of course to increase the rates to the point of breaking the activity. In Frankfurt, we seem ready to go very, very far to extinguish the rise in prices. Some members of the ECB’s executive board are suggesting that the fight against inflation will be fought through sweat, blood and tears. At the end of August, during the great rally of central bankers in Jackson Hole, Isabel Schnabel, who sits on the executive board of the ECB, called for action “with force, even at the risk of reduced growth and rising unemployment. in other words, central banks are likely to face a higher sacrifice ratio than in the 1980s.” A speech that worries Eric Dor: “If the idea is that we have to adjust to the scarce supply of energy and reduce GDP by 30%, yes, we will lower inflation”. This is all the more worrying since the ECB itself seems to believe only halfway in its economic scenario. During the press conference on September 8, Christine Lagarde indeed admitted that certain elements of a darker economic scenario had begun to materialize, referring in particular to the closure of the Nord Stream 1 pipeline, sharply reducing the supply of Russian gas to the ‘Europe. “The people at the ECB are aware of the risk, continues Eric Dor. But we need to bend our chests. Because we are gesticulating, people will think that we are going to lower inflation. They will therefore want to protect themselves against it less. “. Employees will ask for fewer wage increases, and companies will increase their prices less, and we will thus have broken the infernal spiral of cost, price, wages. But wouldn’t there also be a more political reason behind these gestures by the ECB? The co-founder of the management company Orcadia, Etienne de Callataÿ, thinks so. “The main reason for this action by the ECB is hidden, he said. It is a question of responding to popular discontent. It is important to show, when you have technocratic power, that you have heard the discontent and that we react. But the remedy is very expensive: it will weigh on the activity, when it is already slowing down. It is a perfect anti-timing.” Some also argue that the rise in European rates is also necessary in order not to weaken the euro too much against the dollar: many of our imports are denominated in greenbacks and a rise in the American currency fuels the rise in prices even more. Etienne de Callataÿ is skeptical: “this cannot explain three or four points of inflation”. And Vitor Constâncio also dismisses this argument: the interest rate is not the only element that explains the strength of a currency. It is also based on the strength of the underlying economy. The stubbornness of the ECB therefore seems surprising to many. Admittedly, the Central Bank had known for years that having such low interest rates was abnormal. It is therefore announcing today that it is embarking on the path to standardization. A path it should have taken in 2018, however, when the US Federal Reserve also began raising rates. But the ECB waited and only really started its normalization last July, by raising its rates for the first time. “It’s like an airplane waiting for the very last moment to take off, observes Philippe Ledent. He arrives at the end of the runway, but he decides to take off anyway.” And in this takeoff, we, the passengers of the plane, therefore risk being somewhat shaken.


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