The European Central Bank will cut back the monthly volume of its bond purchases. “This is not a reduction, but a readjustment,” said ECB President Christine Lagarde on Thursday. Most recently, the central bank bought bonds worth around 80 billion euros per month. In future, the volume should be “moderately less”, according to the decision of the Governing Council. Nothing will change in the total scope of the EUR 1.85 trillion aid program to cope with the economic consequences of the corona pandemic. This program is to be continued until at least March 2022. By purchasing the promissory notes, the central bank is lowering the interest rate level of the economy as a whole. This increases the incentive to invest. The ECB expects growth in the euro zone of five percent this year.
The ECB’s loose monetary policy is in conflict with rising inflation rates. In August, consumer prices in the eurozone rose by three percent, the fastest they have been since 2011. In Germany, inflation has reached its highest level in almost 28 years. Goods and services were on average 3.9 percent more expensive in August than in the same month of the previous year. For comparison: in June 2021 the inflation rate was still 2.3 percent, in December 2020 the average prices even fell.
The Bundesbank expects the inflation rate in this country to climb to five percent this year. The price surge in the USA is even more striking: there consumer prices have recently increased by 5.4 percent. So far, Lagarde has assumed that consumer prices will normalize in the next year. For 2021, the monetary authorities expect an inflation rate of 2.2 percent.
Interest rates are low, global debt is higher than ever
The ECB and the US Federal Reserve are aiming for an inflation rate of two percent in the medium term. Both institutions recently decided to temporarily accept higher inflation rates. With this decision, the central bankers were able to gain more leeway to continue the loose monetary policy longer. Some member states of the euro zone can only finance their budget deficits if interest rates remain close to zero percent. Companies in Europe and the USA have also got used to favorable refinancing conditions. Meanwhile, global debt is higher than ever.
Christine Lagarde has been President of the European Central Bank since November 1, 2019 and the first woman to hold this office.
(Photo: POOL / REUTERS)
The rising prices are an alarm signal. At the same time, the ECB and the American Federal Reserve fear a quake on the stock markets if they reduce their aid too abruptly. The exit can therefore only be achieved with a certain lead time, and it has to be communicated skilfully. The danger: if central bankers let inflation rates go too high, they lose confidence.
“The Governing Council must prove that it is pursuing the goal of price stability if necessary against the interests of the national finance ministers. In this respect, the first triple step must be followed by further clear announcements in the coming months for an exit from the crisis policy,” demands ZEW economist Friedrich Heinemann.
The financial world has got used to the loose monetary policy
But the “exit” is difficult. The financial world has got used to the loose monetary policy over the past twelve years. After the outbreak of the global financial crisis, the ECB began purchasing Pfandbriefe worth billions as early as 2009. A year later, government bonds from financially weak countries such as Italy and Greece were purchased. It was the time of the euro sovereign debt crisis. On the stock exchanges, financial bets were running on a collapse of the monetary union. It was only Draghi’s “Whatever it takes” promise that ended the spook in 2012. The central bank subsequently lowered the key interest rate to zero percent, and later the monetary authorities also charged negative interest on bank deposits for the first time.
With the so-called APP program, the central bank made a major entry into the financial markets in 2015. By 2020, the ECB had bought bonds worth around EUR 2.5 trillion. The APP program continues to this day. 20 billion euros flow into the market every month. As soon as bonds mature, the central bank takes the money to buy more promissory notes. So there is a constant flow of capital, even if the 1.85 trillion euro Corona emergency program ends as planned in March.
What’s next? It depends on inflation. So far, the central bankers have assumed that the surge in inflation will subside in the next year. Because inflation rates are compared on an annual basis, the massive drop in prices of the previous year, triggered by the economic consequences of the pandemic, is now having a strong mathematical impact. There are other special factors: In Germany, the VAT rates were raised again to the usual pre-Corona level at the turn of the year. Energy prices also rose sharply because a CO₂ tax of 25 euros per tonne of carbon dioxide emitted has been due since the beginning of 2021.
However, it cannot be ruled out that inflation rates will rise in the long term, especially if the production bottlenecks in some sectors lead to ever higher prices. These additional costs are passed on and reach the economy as a whole. Inflation risks lurk elsewhere as well. The environmental protection organization Greenpeace warns in a recent study: Natural disasters had an impact on the inflation rate between 1996 and 2021. In the case of food in particular, one sees strong price effects, triggered by ever more frequent natural disasters, which destroy harvests and interrupt the water supply.