How will the ECB respond to a slower economy with higher inflation?

by Shaun Richards

This morning brought an example of the dilemma facing the European Central Bank ( ECB) and the Euro area. We can start in Spain.

The annual rate of the Industrial Price Index (IPRI) general in the month of February 40.7%, five points above the record in energy and the highest level since the beginning
of the series, in 1976.

Even for these times producer prices rising at an annual rate of around 40% creates a stir and iy will be feeding into an already inflamed situation.

A lorry drivers’ strike, mass protests by farmers and fishermen, industrial production stoppages: record inflation levels have fuelled growing anger with Spain’s left-wing government as energy prices go through the roof.

After a weekend which saw tens of thousands hit the streets, demonstrators were to head out again on Wednesday evening for further rallies.

Under the slogan: “Rein in prices, protect jobs, stop the deterioration in living conditions”, the action has been called by Spain’s top unions, UGT and the CCOO Workers Committees. ( EURACTIV)

This is in response to this.

Backed by consumer groups, the unrest comes as Spain saw consumer prices surge to their highest level in almost 35 years, with inflation jumping to 7.6% in February, against a backdrop of soaring energy costs, worsened by the war in Ukraine.

So the existing problem looks set to last which of course is the opposite of the rhetoric from the ECB that the problem will fade in 2022. Returning to this morning’s release the energy issue is really blowing out.

Energy, whose variation is situated at 114.4%, more than 23 points over the month previous and the highest since the beginning of the series. This behavior is due to ascents of the production prices, transport and distribution of electrical energy, in front of the low of the previous year and, to a lesser extent, of the oil refinery, greater this month than in february of 2021.

Of course the central bankers have for many years tried to get away with calling energy non-core but have gone quiet on that front. I suspect they are afraid of an “I cannot eat an I-Pad” moment or comparisons with Marie Antoinette.

Economic Weakness

We can now switch to Italy and the numbers below were before its defeat by North Macedonia last night ( congratulations to them).

In March 2022, the consumer confidence climate diminished from 112.4 to 100.8. The unfavourable confidence evolution is mainly due to the deterioration of both the economic and future climate (they crashed from 129.4 to 98.2 and from 116.6 to 93.5, respectively). Albeit less strong, negative signals emerged also from the other two index components: the personal climate decreased, in fact, from 106.8 to 101.7 and the current one from 109.6 to 105.7.

That is quite a plunge as the consumer confidence indicator was above 117 in both November and December. The economic climate was above 139 in both those months and is now 98.2.

You will not be surprised to read that such a move is already impacting the retail sector.

The retail trade confidence index fell from 104.5 to 99.9. Negative indications came from the expectations
and (even if to a lesser extent) from the assessments for sales, whereas inventories were considered to
have diminished (the balance of the variables varied from 18.4 to 7.9, from 5.6 to 1.4 and, finally, from 3.1
to 2.5, respectively).

Italy is a significant economy in Europe but the leader of the pack is of course Germany. Recently we took a look at the plunge in the ZEW index and this morning it found some company.

Sentiment in the German economy has collapsed. The ifo Business Climate Index nosedived to 90.8 points in March, down from 98.5 points (seasonally adjusted) in February. This was due to a record collapse in expectations of 13.3 points, which is even more than it fell at the outbreak of the coronavirus crisis in March 2020 (11.8 points). Businesses also assessed their current situation as worse, but the fall here was comparatively moderate (1.6 points). Companies in Germany are expecting tough times.

( Germany IFO)

The breakdown shows a collapse of expectations.

In manufacturing, the index fell faster than ever before. Companies’ expectations also saw a record drop, flipping from optimism to pronounced pessimism. Moreover, companies now rated their business outlook as extremely uncertain…..In the service sector, too, the business climate worsened notably. This was due to a conspicuous drop in expectations. The outlook for the coming months is particularly bleak in the logistics industry.
In trade, the Business Climate Index crashed. The expectations indicator saw a record collapse.

So we have a clear sign of economic weakness and possibly another recession. Here is the German Bundesbank from earlier this week.

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It estimated the German economy likely stagnated in the first three months of the year and the rebound it had pencilled in for the second quarter would now be weaker than expected due to “foreseeable impairments in foreign trade and increased uncertainty”.

Here are the words of Executive Board Member Elderson who like President Lagarde is a lawyer and seemingly a wannabe bricklayer.

The optimal concrete mix ratio depends highly on where the concrete will be used. Generally, the amount of sand and gravel is important for strength and durability, whereas cement and water add to workability.

He did eventually get onto the matter at hand.

After having fallen sharply in the first months of the pandemic, it started rebounding around one year ago and has increased above our 2% target since last summer reaching 5.9% last month. The strength and the persistence in the rebound of inflation has consistently surprised many analysts and professional forecasters, including us.

I do like the way they rush to point out others were wrong but the use of “many” shows some ( me for example) that were right to fear an inflation push. But the crux of the matter is that the old era ECB would respond to this.

Even if global oil prices do not increase any further and stabilise at high levels, we currently expect inflation to be above our 2% target well into 2023, before settling around target in 2024.

That is central banker code for we will raise interest-rates and some markets believe it along the lines of Paul Simon.

Everybody loves the sound of a train in the distance
Everybody thinks it’s true.

But there is an obvious problem with the issue being now and you supposedly responding later. Unless of course you can time travel like Dr.Who.

The ECB response these days is to emote.

We are aware that the current spell of high inflation has a consequential impact on many citizens’ personal livelihoods in a time in which both economic and a broader sense of uncertainty have again taken hold

And also in this bit to lie.

Let me reiterate: our commitment to medium-term price stability is unwavering.

He confesses this in his very next sentence.

With inflation stubbornly above our target for so long,


Let me now give my view and what they will do. Just as a reminder inflation is approximately triple its target so?

This strengthens our policy optionality by removing obstacles for potential policy rate normalisation beyond the horizon of our asset purchases.

This is a classic deferral waiting for something to turn up which is further confirmed here as that poor battered can gets yet another kick.

Any adjustments to the key ECB interest rates will take place some time after the end of our net asset purchases and will be gradual and based on the incoming data.

Or as Talking Heads put it.

You start a conversation you can’t even finish it
You’re talking a lot, but you’re not saying anything
When I have nothing to say, my lips are sealed
Say something once, why say it again?

Putting it another way we could soon be seeing another QE programme as the economy is plainly very weak ( no doubt to be presented as another surprise) and they are afraid to cuts interest-rates further as the banks lack a business model as it is.


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