A resolute ECB, but for how long?

Florent Delorme,
Macro Strategist

 

The European Central Bank’s stance is becoming increasingly inflexible, in line with that of the US Federal Reserve. But can the ECB maintain this stance over the long term?

The ECB has recently increased its key interest rate to 1.25%. Although this level is still accommodative and does not seem absurd given the current inflationary dynamics, the ECB has announced that it intends to continue to tighten its monetary policy, making beating inflation its sole priority and leaving aside the possible consequences of such a policy. This increasingly firm tone seems to leave no place for a wider reflection on the economy and stability of the eurozone. In this respect it is worth noting the points which would justify a more nuanced approach by the European monetary authorities.

First of all, it should be noted that the links between the level of interest rates and inflation are a complex issue and that there is no linear relationship between the two parameters. Should the question of inflation therefore be reduced simply to the level of key rates, bearing in mind that the eurozone’s current inflation stems mainly from rising energy - in particular gas - prices, while, at the same time, there is no wage inflation, inflation expectations remain moderate and it is difficult to link the current rise in prices to exuberant lending to households and businesses? It is argued that demand restraint is necessary even in the case of inflation caused by a supply crisis. But is it really reasonable to want to restrict demand to this extent, when demand, excluding the “catch-up” effects linked to the rebound from the health crisis, remains structurally low?

It should also be borne in mind that recent decades have demonstrated the structural weakness of European growth, in particular as a result of the low productivity, investment gap and deindustrialisation of the continent and the inadequate upgrading of production, with the exception of Germany. Accordingly, the obligation to boost growth and investment through low rates has become a widely shared idea. The structural weaknesses of the European economy have not disappeared and the need to ensure accessible funding over the medium term continues to be equally important.

It should also be emphasised that the increase in funding costs could prove problematic for Italy, even France, with the risk of jeopardising the eurozone’s stability.

Moreover, it must be borne in mind that the continent’s political fragility, as demonstrated by the upsurge in populist movements, precludes any return to monetary or fiscal austerity policies. The establishment of massive tax shields to limit energy price increases is the most recent demonstration of this, as well as the re-opening of coal-fired power plants, while, at the same time, the European Union wants to commit itself to a proactive policy of cutting emissions.

Finally, this last point leads to the need to finance the energy transition, which will only be possible within the framework of an ongoing accommodative monetary policy.

For all of the abovementioned reasons, the ECB will no doubt have to revert to a more nuanced stance very rapidly.

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