There is a reason the ECB has not raised interest-rates for more than a decade

by Shaun Richards

This week has been a story of central banks raising interest-rates with the main player in the pack being the US Federal Reserve followed by the Bank of England. Those of you familiar with my work will know I think that the recent Bank of Canada move was in the same  vein albeit they copied the expected move from the Fed. Such moves remind us though that in Europe the main central bank has done nothing in spite of inflation soaring about target.

The euro area annual inflation rate was 5.9% in February 2022, up from 5.1% in January. A year earlier, the rate
was 0.9%

The essential problem here is that the target is 2% and we have seen days when the ECB was an enthusiastic inflation targeter. Let me take you back to July 2011.

Based on its regular economic and monetary analyses, the Governing Council decided to increase the key ECB interest rates by 25 basis points, after raising rates by 25 basis points in April 2011 from historically low levels.

This was in response to this.

With regard to price developments, euro area annual HICP inflation was 2.7% in June 2011 according to Eurostat’s flash estimate – the same rate as in May. The relatively high inflation rates seen over the past few months largely reflect higher energy and commodity prices. Looking ahead, inflation rates are likely to stay clearly above 2% over the coming months.

So it responded then to similar themes but an actual inflation level of less than half now.

President Lagarde

The current ECB President told an audience in Frankfurt this yesterday.

The Governing Council last week agreed that its response will be guided by three principles: optionality, gradualism and flexibility.

It would appear she is the only central banker who still thinks they can get away with claiming inflation is transitory.

First, volatile growth has led to volatile short-term inflation.

Actually the issue is that it has risen and indeed substantially, which she then inadvertently admits.

Durable goods inflation is 16 times higher today than it was in February 2020.

Things get even odder when she tells us that the beginning of a war has done this.

In many ways, the best analogy for what we have seen is the spurt in inflation that typically accompanies the end of wars,

But anyway don’t worry about having all this inflation because at some point it will get better.

Inflation expectations have also converged to our target of 2% across a range of measures, while inflation has become broader and measures of underlying inflation have risen.

The next bit is worthy of Orwell’s 1984.

We also adjusted our communication in February as the incoming data suggested that inflation was converging even faster towards our medium-term goal.

Inflation is almost treble the target!

The theme of a The Outer Limits style of fantasy is compounded here.

These effects are reflected in the ECB staff’s baseline projection, which sees slower but still relatively robust growth this year at 3.7%. But in the severe scenario GDP growth could be up to 1.4 percentage points lower than the baseline this year.

Meanwhile back in the real world we noted earlier in the week the plunge in the German ZEW sentiment index to which we can add this.

Sharply slowing electricity use in Germany points to increasing demand destruction due to high energy prices and supply disruptions halting activity. (Temp. was about same as last year to date in March). ( @OliverRakau )

Remember when we used to look at electricity use in China when we could bot trust the official rhetoric? Well add Germany to that list.

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Those looking for growth from Spain have to explain how that can co-exist with real wages falling at an annual rate of just over 5%.

For those of you keeping score about wage inflation and second round effects in the euro area, negotiated salaries in Spain rose 2.3% in annual terms in February (inflation is currently 7.6%). ( @atalaveraEcon )

What will she do?

Not much.

As a result, we decided it was appropriate to continue dialling back our net asset purchases, which were intended to combat an environment where disinflationary risks dominate.

If she believes her own thetoric then there is no reason for there to be any asset purchases right now.

Under all scenarios, our stock of asset purchases is providing significant accommodation – it will exceed €5 trillion by the third quarter and will be reinvested even after the end of net purchases.

I think that is called trying to have your cake and eat it.

First, optionality should not be confused with ambiguity.

It is ambiguous.

Second, gradualism is a well-established principle for central banks in times of uncertainty.[24] When faced with uncertainty about the resilience of the economy, it pays to move carefully.

When the Covid crisis began central banks reacted instantly.

Third, flexibility is a special principle for conducting monetary policy in a monetary union, as we must continually focus on ensuring that policy is transmitted evenly to all parts of the euro area.

The flexibility is to respond instantly to a downturn and to dither about inflation. As to even policy let me return you to the detail of the inflation numbers.

The lowest annual rates were registered in Malta, France (both 4.2%), Portugal, Finland and Sweden (all 4.4%).
The highest annual rates were recorded in Lithuania (14.0%), Estonia (11.6%) and Czechia (10.0%).

Care is needed with the French number as only last night President Macron conformed that the bill has gone from the consumer to the taxpayer.



We find that the present crisis has brought us right back to one of my themes about the ECB and the Euro area.

We’re caught in a trap
I can’t walk out
Because I love you too much, baby
Why can’t you see
What you’re doing to me
When you don’t believe a word I say? ( Elvis Presley)

This is why President Lagarde is forecasting strong economic growth when the prospects are poor and going into denial about inflation. We can also reflect on the words of Isabel Schnabel at yesterday’s conference.

The green transition will herald a new age of energy inflation, says Executive Board member @Isabel_Schnabel

. We will continue to protect people’s purchasing power, green our operational framework and work for change in financial markets. ( @ecb)

I remember warning that the central banking adventure into green policy would be a disaster but have to confess that even for them this is fast. Rather curiously Isabel was recycling a speech from January.

While in the past energy prices often fell as quickly as they rose, the need to step up the fight against climate change may imply that fossil fuel prices will now not only have to stay elevated, but even have to keep rising if we are to meet the goals of the Paris climate agreement.

It is her plan to raise prices and inflation. How that protects purchasing power only she knows.

I know that financial markets are predicting a couple of increases in ECB interest-rates albeit conveniently in the distance. But with us set for stagflation I cannot see how that will happen. If they were bothered about inflation they would have responded and they have not. So we are expected to believe that they will raise interest-rates into a weaker economy?

Perhaps it has a touch of the Vapors.

I’m turning Japanese
I think I’m turning Japanese
I really think so


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