analysis
Inflation remains far too high. It is unclear whether the ECB will continue to increase interest rates. Critics no longer give monetary politicians a chance anyway: the current inflation cannot be tamed with their resources.
Summer is slowly coming to an end. The approximately 3,500 employees of the European Central Bank (ECB) are back in the Eurotower on the Main. The spectacular glass and steel building has been closed for the past few weeks. Large parts of the electrical system had to be replaced under enormous time pressure.
Little was heard from management – even when working from home or on vacation. President Christine Lagarde avoided giving controversial interviews in women’s magazines, such as the French magazine “Madame Figaro” last July. Most council members also held back from making statements.
Inflation rising again in France
However, there was hard work behind the scenes. This week the ECB publishes its new inflation forecast. She could have it all. So far, the persistent inflation has shown itself to be stubborn and is not easing as desired. In August, the inflation rate in the euro area was 5.3 percent, unchanged from the previous month. In Germany, according to European calculations, it was even higher at 6.4 percent and has only fallen by a meager 0.1 percentage points compared to July.
Inflation increased significantly again in France, Austria and Croatia – and it remains particularly severe in Slovakia at 9.6 percent. In Spain, too, which has long been a model country in combating inflation, the inflation rate rose from 1.6 percent in June to 2.4 percent now.
Rifts in the ECB Governing Council are opening up again
“We will break the back of inflation,” promised ECB President Lagarde after the last council meeting in July. During one of her few appearances in the summer, at the central bank conference in Jackson Hole, USA, she also found clear words: “The fight against inflation has not yet been won.” According to the ECB President, interest rates must be kept “restrictive” until the inflation target of two percent is reached again.
But the pithy words leave little impression on many economists and large parts of the financial market: a narrow majority there is even of the opinion that the ECB will take a break on key interest rates this week and will not increase them further, according to the results of a survey by the news agency Bloomberg.
Because the old rifts in the ECB Council are opening up again: the hardliners, such as the central bank heads from Germany and Austria, do not yet see an end to the interest rate cycle. From the Netherlands, otherwise more in the camp of the so-called “hawks” – i.e. the supporters of a stricter monetary policy – one hears cautious tones. However, the inflation rate there has also fallen significantly. In Portugal, people have been putting on the brakes for months and are increasingly finding support in Italy and Greece.
Construction crisis and high oil prices
These countries point to the weak economy, which will be further weakened by the nine interest rate increases. In fact, loans have become much more expensive and are leading to higher costs for companies, which are therefore holding back. Demand for credit has fallen to its lowest level since the ECB was founded. The effects of interest rate increases in the construction sector are particularly drastic: numerous planned projects can no longer be financed and have been discontinued. The number of building applications fell rapidly. The first bankruptcies are occurring among project developers. Overall, the sector is slipping more and more into crisis.
However, large parts of the population do not see why they should pay the bill by continuing to have to dig particularly deep into their wallets. There is no relief, especially when it comes to food and fuel, and in some cases prices are even rising again. This is mainly due to the continued high prices on the oil market. There, OPEC+ in particular is causing high prices with production cuts. The main driver, Saudi Arabia, is supported primarily by Russia. Moscow has the greatest interest in high revenues in order to finance the war of aggression against Ukraine.
The ECB’s monetary policy has no influence on the prices for energy and food anyway because interest rate increases have no effect there. The two positions are therefore often excluded from the inflation rate. Then you get what’s called “core inflation.” But that is also almost three times as high as desired.
Less global competition as a cost factor
The question of whether the ECB is even able to effectively combat inflation with its resources is becoming increasingly important. According to some experts, the economic conditions have changed structurally in the wake of the Corona crisis and the Ukraine war to such an extent that traditional monetary policy no longer has any effect. For example, advancing de-globalization has led to a decline in international competition. This allows companies to charge higher prices. In addition, raw materials remain scarce and expensive.
The massive arms spending by Western countries to support Ukraine in the fight against Russia also keeps inflation at a high level. Because all that money ends up in circulation and fuels inflation. This also applies to the massive costs of the energy transition as a result of climate change. “We spend hundreds of billions on this and what we get in the basket is not goods, but clean air,” says Hendrik Leber, managing partner of the capital management company Acatis Investment, in an interview with Deutschlandfunk. “That also drives inflation.”
Added to this is the lack of workers everywhere. They fuel inflation because companies have to pay higher wages in the long term if they want to retain employees. In order to get inflation under control under these circumstances, interest rates would have to be raised to double-digit rates, say many experts. But the ECB would never do that. Hendrik Leber is therefore convinced that inflation will not fall significantly: “You cannot eliminate the structural issues. The central banks’ resources are limited.” Reaching the two percent target is illusory.
Is the inflation target outdated?
This is also the opinion of many universities and some banks. The suggestion that the ECB should adjust its inflation target and increase it to three percent comes up again and again. Otherwise, failure is inevitable. The chief economic advisor of the major Italian bank UniCredit, Eric Nielsen, even suggests a target corridor of three to four percent to the ECB. If it stays at two percent, “then it only works if it causes lasting pain to the economy – that is, less real growth,” he told the “Börsenzeitung”.
But the ECB simply cannot afford a failure or a tricky adjustment to the current inflation target. It has promised the population too clearly and clearly that inflation will fall. If Christine Lagarde does not deliver what she has announced, the already weakened trust in the monetary authorities is likely to continue to dwindle. In the worst case scenario, this could not be the downfall of inflation, but of the ECB itself in the long term.
The council members are only too aware of all this. There are likely to be heated discussions in the reopened meeting room on the 43rd floor of the Eurotower. It’s good that at least the technology is running smoothly again.