ECB interest rate policy: The rumblings are getting louder

High inflation and the turnaround in interest rates initiated in the USA are increasing the pressure on the European Central Bank. Business associations fear that the economy will stall and are calling for a change of course.

It was quiet in the Frankfurt Eurotower, because the building was almost deserted because of Corona. Outside, the big Christmas tree was lit up next to the main entrance. The weather was gray and dreary, pre-Christmas calm seemed to prevail. In fact, behind the scenes at the European Central Bank (ECB), scraps were flying in December. Supporters and opponents of the ultra-loose monetary policy, the so-called “doves” and “hawks”, faced each other with growing irritation. The Governing Council was more divided than it had been for a long time: three members, including Jens Weidmann, head of the Bundesbank who has since left office, voted against the December resolutions.

High inflation probably not temporary

With these resolutions, the old bond purchase program from the times of the financial crisis will be extended. This makes an interest rate turnaround in Europe this year virtually impossible. That can only come when the purchase program is ended. Belgium’s central bank chief Pierre Wunsch was also against it, but was not allowed to vote because he had to sit out the rotation principle in the Governing Council.

So there is rumbling in the body, the fronts are hardened. This trend is likely to intensify this time. After the US Federal Reserve virtually set the rate hike for March in stone last week and apparently intends to tighten the reins much more tightly than previously expected, calls for the ECB to take action against the high price increases in the euro area are becoming louder. The inflation rate was 5.0 percent last year and rose to a new record high of 5.1 percent in January. In Germany it was 4.9 percent at the beginning of the year.

Doubts are growing about the arguments put forward by ECB President Christine Lagarde and her chief economist Philip R. Lane, both leading “doves” on the ECB Council, that inflation will fall significantly again this year. Gritting her teeth, the boss had to admit that the inflation forecasts had been wrong. That for this year has almost doubled to 3.2 percent. Nevertheless, one does not want to take countermeasures, the doves continue to reject a turnaround in interest rates.

Business associations are also getting restless

The banks, whose business model has suffered serious cracks in view of the low interest rate level and penalty interest, have been fighting back for months. A circumstance that consumers have to bear the brunt of, who are now being asked to pay for every service, no matter how small, or who have to pay penalty interest themselves. And now the German trade associations are up in arms.

After the meeting of the US central bank, the German Chambers of Commerce and Industry (DIHK) and the Federal Association of Wholesale, Foreign Trade and Services (BGA) called on the ECB to initiate an appropriate turnaround in interest rates as well. “It’s time to finally end the expansive monetary policy, even if this leads to higher interest rates for the state budgets,” says BGA President Dirk Jandura. After all, it is not the task of the ECB to restructure ailing national budgets. DIHK foreign trade chief Volker Treier warned in the “Handelsblatt” of an increasing spiral of inflation. It is “a dangerous explosive device for every economy – especially for ours,” says Treier.

Old arguments no longer work

It is thus becoming increasingly clear that the justification given by the ECB for the loose monetary policy is becoming increasingly absurd. At its core, it consists in the fact that a glut of money and low interest rates are intended to help companies obtain capital cheaply in order to stimulate the economy. In fact, European companies no longer need this help. You have enough money to invest. What they need is a significant drop in material costs, the prevention of a wage-price spiral and a euro exchange rate that does not drop too much.

However, none of these developments are being curbed by the current monetary policy, rather they are being fueled: the exploding raw material costs with double-digit price increases in the upper range are increasingly becoming a stumbling block for production. A wage-price spiral, in which workers understandably demand significantly higher wages to compensate for the sharp rise in costs, would put an additional burden on companies.

The weak euro exchange rate is also becoming more and more of a problem: Although it makes export goods cheaper, it also dramatically increases the price of importing important raw materials such as crude oil, gas, plastics, metals and chemical products, which are usually billed in US dollars. However, its value is increasing compared to the euro, because the upcoming turnaround in interest rates in the USA is making the currency very lucrative and triggering correspondingly large shifts in the financial sector. In the past six months alone, the dollar exchange rate has risen by around ten percent against the euro.

The ECB’s reputation could suffer

But it’s not just companies that are groaning under the ECB’s monetary policy. Consumers are also becoming increasingly restless in the face of skyrocketing costs for electricity, heating and food. Many believe that the ECB does not take its main task – fighting inflation – seriously enough. From the point of view of ex-ECB chief economist Otmar Issing, this could have serious consequences for the central bank’s reputation. “If inflation stays high, the ECB faces an enormous loss of reputation, especially in Germany, where the population is particularly sensitive to inflation,” Issing told Wirtschaftswoche newspaper.

Jürgen Stark, Issing’s successor in the office from which Issing resigned in protest against the loose monetary policy in 2012, warned in the “Welt” that there was a risk that the ECB “if it hesitated further and inflation continued to be high, will no longer be accepted in the appeasement”.

Changes not recognized?

Most critics accuse the monetary authorities of not recognizing that the pandemic has changed the structure of the global economy. In fact, more and more companies are bringing parts of production back to Europe from the Far East due to supply bottlenecks, which, however, increases costs over the long term. There is therefore currently little evidence of a significant drop in inflation, as monetary watchdogs keep claiming.

At the ECB Council meeting this week, the lines of conflict are open. At the moment, the “doves” camp is dominant, but there is increasing resistance. Not an easy start for the newcomer either: Joachim Nagel, head of the Deutsche Bundesbank since the beginning of the year, is taking part in an ECB meeting for the first time and would certainly have wished for a more pleasant start. So it should be busy again behind the scenes of the Frankfurt Eurotower. Because of Corona, it is still largely deserted and sinks into the gray, cloudy, dirty weather.