The ECB is slamming the brakes on the Euro area economy

by Shaun Richards

Next week we get the latest policy announcement from the ECB for the Euro area and there is not much doubt over what will be announced.

One of them is that we, at this point in time, expect and judge that we will have to raise interest rates significantly. Now, what does that mean? You have to read it together with the steady pace. It is pretty much obvious that, on the basis of the data that we have at the moment, significant rise at a steady pace means that we should expect to raise interest rates at a 50-basis-point pace for a period of time.

That was President Lagarde precommitting the ECB for next week back at the December press conference. That was extraordinary in various ways not least because only a couple of months ago or so before she had abandoned Forward Guidance.

This left Executive Board Member Fabio Panetta in a spin earlier this week.

It was reasonable to increase rates in December and signal a similar step in February. But beyond February any unconditional guidance – that is, guidance unrelated to the economic outlook – would depart from our data-driven approach.

Fortunately for him the Handelsblatt journalists completely missed the fact that President Lagarde had already precommitted the ECB for 2 meetings.

Money Supply

This morning’s data release gives us a look at how the monetary sector has responded to the moves so far.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to 0.6% in December from 2.4% in November.

I have picked out the narrow money measure because that is a guide to what is coming this year for late spring and early summer. As you can see there is a bit of a warning in it from the decline in the annual growth rate. In fact we see that over the latest 3 months it has fallen by 148 billion Euros then 100 billion and 112 billion in December. So we are seeing quite a hard contraction. As an aside cash ( currency in circulation ) has been flat and in fact literally zero over the latest 3 months. So as I have pointed out regularly it is much more in demand than the establishment likes to claim and of course is doing so when there is a cost to it via higher interest-rates.

Next up for longer-term trends is broad money.

Annual growth rate of broad monetary aggregate M3 decreased to 4.1% in December 2022 from 4.8% in November.

Let me illustrate how broad money works via looking back to 2020 when broad money growth went above 12% and had a sustained period over 10%. That signalled quite a push for nominal GDP and as economic growth has struggled for many years was always likely to lead to high inflation. We now know that my predictions at the time ( feel free to look back) that inflation was coming worked pretty much perfectly.

But now we see that not only is the annual rate falling quite quickly actual growth over the past three months has been a fall of 78 billion Euros. So in fact the nominal GDP forecast a couple of years ahead is flat or marginally negative.

Not Learning Anything

As I have just explained the seeds for the current inflationary burst were evident at the end of 2020. Now let me switch to the ECB version of events via Chief Economist Phillip Lane.

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Let me, first, give you a reminder of the last 15 months or so. Inflation pressures were starting to build from the summer of 2021. So maybe the first meeting at which this was sufficiently visible in the data would have been December 2021. But December 2021 was also when the Omicron variant was emerging.

That was a reply to a question in the Financial Times about whether he was happy with the past couple of years. As you can see he has not only moved the goalposts they are on wheels as according to him nothing was visible until December 2021. Even then he has an excuse ready for failure.

Let me take you back to September 27th 2021. Unfortunately we cannot hear from Phillip Lane as he was caught in a scandal about him briefing large hedge-funds butt his boss ECB President Lagarde assured us of this.

many of the causes of higher prices are temporary.

So it wasn’t that the data was unavailable it was that the ECB dismissed it. Actually it gets worse in her next sentence.

When you look at what’s causing it, a lot of it has to do with energy prices. You look back a year ago, prices were rock bottom. They have of course moved up and the difference is explaining a lot of the inflation that unfortunately people are experiencing at the moment.

As you can see energy prices were an issue a long time before the war in Ukraine. It might things worse but there was already quite a big problem. I point this out because central banks keep trying to claim that the issue was only as a result of the war in Ukraine.

What we got from Phillip Lane was a rather desperate effort to deny reality.

So, what we did between December 2021 and June 2022 was focus on reducing QE, before starting to raise rates, in the knowledge that we could move relatively quickly once we started raising rates.

Imagine the manager of a losing football team trying this. I did not make any big changes as we kept losing as I was getting ready. But it gets worse as Chief Economist Lane now outright lies.

The debate about the exact timing is misplaced, because we knew that we could always catch up if it turned out that rates needed to be moved more quickly. In the end, where we are now is reasonable.

Even basic students of economics know that it takes time for interest-rates to impact and thus timing HAS to matter.

Comment

The situation is simply that the ECB made things worse by ignoring the incoming inflation storm and now seems set to continue tightening when the outlook is better. So they made it worse on the way in and now look set to do so on the way out. If we look at energy the situation looks better.

US natural gas futures fell below $3/mmbtu for the first time since May 2021 ( @SStapczynski )

Whereas the economic situation continues to have its problems.

Chemical maker Dow says it will shut down certain operations, “particularly in Europe,” as it confronts higher energy costs and a slowing economy ( @RefinedRachel )

I do realise that this comes at the moment that Euro area leaders are cheerleading for economic growth.

Germany to Quash Recession Fears With 2023 Growth Forecast

  • Government to publish forecast of 0.2% expansion this year
  • Economy Ministry had predicted contraction of 0.4% for 2023 ( Bloomberg)

But then of course they also told us there wasn’t going to be any inflation.

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