ECB measures make sense, but won’t be enough



If you think the Federal Reserve is struggling to control inflation, spare a thought for the European Central Bank. On Thursday, President Christine Lagarde announced the ECB’s first interest rate hike in 11 years – a bigger-than-expected hike of half a percentage point, taking the key rate from minus 0.5% to zero. . She also presented a future transmission protection instrument, a debt purchase scheme intended to protect against “unjustified and disorderly market dynamics”.

These measures, although good, do not in any way guarantee an orderly return to economic stability.

Prices in Europe rose nearly 9% in the year to June, about as fast as inflation in the United States, but the causes differ in a way that makes the task of the ECB much more difficult. Excess demand, a problem that monetary policy can address, has played a prominent role in the United States. In the eurozone, not so much: the supply shock due to Russia’s war against Ukraine and energy supply interruptions is much stronger, reducing the central bank’s scope for action.

Unemployment is also higher in Europe than in the United States, which increases the risks of excessive tightening. Worse still, conditions vary widely between members of the currency zone: some are well positioned to cope with higher rates and some, burdened with heavy debt, are not.

That’s a lot for a central bank to manage – and it doesn’t help that European governments are in a state of disarray. In France, President Emmanuel Macron no longer has a majority in parliament. Germany’s new leader, Olaf Scholz, is struggling to explain his policy towards Ukraine and now has to deal with further gas supply cuts from Russia. And the highly respected Italian Prime Minister, Mario Draghi, resigned, frustrated by lawmakers’ refusal to work together.

Amid this leadership vacuum, Lagarde and his colleagues are doing all they can. Given the circumstances, their reluctance to raise interest rates earlier was justified. This first unexpected increase is logical because inflation has worsened and the ECB must show that it is at work. And Lagarde is right to make no promises about how rates will move from here, stressing that it will depend on how conditions change. (The Fed, by the way, would do well to take the same approach for its own forward guidance.)

Greater clarity, on the other hand, will be needed on the new “anti-fragmentation” instrument. The TPI will allow the central bank to buy the bonds of countries that are struggling to service their debt and facing high interest rate differentials. Lagarde set out general principles but did not go into details. She declined to say whether Italian debt was on her list, insisting the ECB would retain discretion within eurozone fiscal rules. Right now, even the ECB itself may not know what this means, let alone analysts studying its statements.

They will know soon, because the new instrument is likely to be tested. The financial markets were initially impressed by Lagarde’s announcements, but the mood did not last and the euro gave up its first gains. A heavily depreciated currency further contributes to inflation. Spreads on Italian and other debt did not narrow. And the energy shortage is likely to get worse before it gets better.

In short, Europe’s half-built fiscal and monetary union faces another brewing storm. It will struggle to meet this challenge unless member governments step in. Above all, they will have to cooperate more closely to manage their debts and share the burden of the energy shortage – a job for elected politicians, not bureaucrats. If they expect to stay away and leave everything to the ECB, they will soon be wrong.

More from Bloomberg Opinion:

• Can Mario Draghi get out of the political rubble? : Rachel Sanderson

• ECB crisis plan fails to convince bond traders: Marcus Ashworth

• What good is hiking when the recession is looming? : Gearoid Reidy

The editors are members of the Bloomberg Opinion Editorial Board.

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