The ECB faces inflation, fragmentation and the risk of recession

by Shaun Richards

Over the last 24 hours the heat has begun to be turned up on the ECB. Not quite literally as whilst they have decamped to the resort of Sintra in Portugal the weather is not so good. It will have to be the sun bed for President Lagarde. Switching back to the economics some extraordinary quotes have emerged.


In fact according to ForexLive he went on to say this about the interest-rate hikes.

“are a no brainer for me”

The problem for the head of the Belgian central bank is if anyone asks him why he has not voted for any so far? We know this because we were told that the decision not to increase interest-rates on the 9th of this month was unanimous.

The situation gets worse for him as we note this morning’s inflation numbers from Spain.

In June, the estimated annual variation rate of the HCPI stood at 10.0%, one point and a half
more than the one registered in the previous month.
For its part, the estimated monthly variation of the HCPI is 1.8%.

So the Euro area measure has reached double-digits and it has soared again on a monthly basis. We only get limited detail at this stage.

This evolution is mainly due to the increase in fuel prices, higher this month than in June 2021,
and in food and non-alcoholic beverages, compared to the stability recorded last year.
The increase in hotel, café and restaurant prices, higher than last year, also played a role.

No doubt our valiant Belgian inflation fighter would want us to focus on numbers like this.

For its part, the estimated annual variation rate of underlying inflation (general index excluding
non-processed food and energy products) increases six tenths, to 5.5%. If confirmed, it would
be the highest since August 1993.

The problem in addition to the “highest since August 1993” bit is that it is not far off treble the 2% target he has. Of course it gas the problem that trying to ignore energy and food costs right now gives off Marie Antoinette vibes.

President Christine Lagarde

Speaking of Marie Antoinette her countrywoman President Christine Lagarde gave the set piece speech. It appears that she no longer thinks that inflation is a “hump”

Inflation in the euro area is undesirably high and it is projected to stay that way for some time to come. This is a great challenge for our monetary policy.

Doe those wondering about this here she is from December.

ECB’s Lagarde: Inflation Profile Looks Like Hump, Though This Hump Will Eventually Decline And We Project Inflation To Decline In 2022 ( @LiveSquawk )

She is now trying to give the appearance of action as even she must realise that double-digit inflation rates are applying pressure.

In response to the changing inflation outlook, we have consistently followed the path of policy normalisation since December last year, sequentially adjusting our policy stance.

Just as a reminder the ECB deposit rate is unchanged at -0.5% the lowest it has ever been in case you think that she is using what “normalisation” gas been defined as previously.

Indeed you know when a central bank is under real pressure because they come up with a new inflation measure.

A new ECB indicator of domestic inflation – which removes items with a high import content – currently stands above 3%.

From this we learn that even a litany of research students and Phds with high powered computers cannot find a way to twist,manipulate and distort the numbers to get inflation back on target. Probably because the inflation has spread as I predicted and President Lagarde denied.

At the same time, inflation pressures are intensifying and broadening through the domestic economy. Almost four-fifths of items in the consumption basket had annual price increases above 2% in April, and this is not only a reflection of high import prices.

Even more embarrassing is this claim.

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Third, these factors combined have led us to project core inflation at 2.3% in 2024 – and, in the euro area, core inflation tends to be an indicator of headline inflation over the medium term.

On the same basis they told us inflation would be 1.2% now. How is that going?

Next on the list is to claim that interest-rates have already risen.

The €STR forward rate ten years out is around 240 basis points above its pre-pandemic level, without policy rates having yet moved. One-year forward real rates, one-year ahead and five-year forward real rates, five-years ahead are around 100 and 140 basis points higher, respectively.

The problem with this is that much of this is due to bond markets following developments abroad where there have been interest-rate increases. The Bank of England is there in a small way but the main player is the US Federal Reserve which has just increased interest-rates by 0.75% and is promising 3% plus. So Euro area rates have been dragged higher in response to this as investors will no longer accept negative bond yields for example.

So far all we have are promises from Christine Lagarde which is awkward as she is the person who called the disastrous bailout for Greece as “shock and awe” and told us her IMF plan for Argentina was going well just before its economy collapsed.

Consistent with moving gradually, we announced that we will end net asset purchases under our asset purchase programme on 1 July and intend to raise our three key interest rates by 25 basis points at our next meeting on 21 July.

But we also announced that we expect to raise the key interest rates again in September, and “if the medium-term inflation outlook persists or deteriorates, a larger increment will be appropriate at the September meeting.”

Fragmentation ( Italy )

This did get a mention from President Lagarde.

Second, the euro area has a unique institutional set-up, built around 19 not yet fully integrated national financial markets and 19 national fiscal policies, with limited coordination. This presents the risk of our monetary policy stance being unevenly transmitted across the union.

Her predecessor unintentionally highlighted the issue in his new role of Prime Minister of Italy.


In any such situation the heat will go straight onto Italy and its bond market.

This is a real problem and let me remind you that back in the day we were told “one size fits all” for monetary policy. This has now become this.

SINTRA, Portugal, June 29 (Reuters) – European Central Bank policymakers are weighing up whether or not they should announce the size and duration of their upcoming bond-buying scheme, designed to curb financing costs for Italy and other debt-laden countries, sources told Reuters.

There is also talk about it being “sterilised” which brings echoes of the Securities Markets Programme for those who want to look it up on here.


We can use this morning’s monetary data to further analyse the rhetoric of President Lagarde and the ECB. You see with inflation at 10%  in Spain and more like 20% in the Baltics she is still doing this.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to 7.8% in May from 8.2% in April.

As there is no economic growth this can only be seen as a continuing push for inflation and looked at like that the change from 8.2% to 7.8% is a sideshow. If we look further ahead ( 18-24 months) we see this.

Annual growth rate of broad monetary aggregate M3 decreased to 5.6% in May 2022 from 6.1% in April (revised from 6.0%)

Again if we assume there will be not much growth then that suggests inflation of 5% in 2023/4.

So as well as the failure of “one size fits all” for Euro area monetary policy they will be dealing with high inflation and a stagnating ( probably shrinking) economy.


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