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After months during which the European Central Bank (ECB) may have seemed to be acting the ostrich on spiking inflation, calling it “temporary”, the ostrich has finally turned into a hawk, determined to tackle inflation aggressively.
Thursday 9 June 2022 will be seen as a black day for the ECB. Through the voice of its President, Christine Lagarde, the Governing Council sounded the end of recess. In circumstances where inflation seems to be slipping through its fingers, the ECB is taking things firmly in hand by announcing both the end of the expansion of its balance sheet and, most importantly, its first rate hike, a decision that has not been taken since 2011.
It must be said that there is urgency, because consumer prices have soared by 8.1% year on year for the eurozone as a whole. Only 18 months ago, the same consumer prices were trending downwards. Inflation has even exceeded 15% in all of the Baltic countries!
Primarily, there is urgency on key rates. The announcement of a 0.25% rise in the deposit rate is not inconsiderable either in substance or in form, as it will be effective at the next meeting on 21 July. Custom dictates that rate increases are first suggested upstream, and then officially confirmed on the day of the meeting. This time, however, the announcement six weeks before the meeting underscores the desire to manage the timing, but also the institution’s need for caution to avoid causing a reverse in the markets and at least give them short-term visibility. The ECB is fully aware of this since it has been scrupulous in explaining that while this measure risks bringing short-term stress to the financial markets, it is nonetheless necessary in order to stabilise financial conditions over a longer horizon. It has to hurt first, before relief can be brought.
Then there is urgency on asset purchases. After having weighted down its balance sheet with more than 4 trillion additional euros since the outbreak of Covid, the ECB will stop buying sovereign bonds from 1 July. So direct support for State financing is now over, to be replaced by free confrontation of bond market supply and demand, at the risk of a significant rise in the cost of financing States, many of which are already heavily indebted.
At any rate, the outcome is hardly encouraging because the path towards peak monetary tightening on which the ECB has embarked is both steep and narrow. The first difficulty hoves into view as early as September: the door is already open for a double increase of 0.50%, if inflation does not fall back during the summer, an eventuality which for the moment seems unlikely.
While it is "urgent to go further", it is also important not to overdo it, at the risk of plunging what is already tenuous growth into the abyss. Godspeed, Christine!
Written on 13 June 2022, by Olivier de Berranger, CIO, LFDE