2023-05-09 06:26:40
The ECB headquarters in Frankfurt. (Photo credits: ECB)
The fight once morest rising prices is far from over. Inflation is setting in and central banks are on the move to avoid any drift. Philippe Trainar explains why, in his eyes, the weapon of rising interest rates will continue to prevail
Many experts were calling for a pause in the rise in intervention rates by the European Central Bank (ECB). They put forward four arguments for this: the recent declines in inflation in the euro zone, the loss of purchasing power of wages, the significant tightening of credit conditions and the current episode of banking stress with the risks of contagion that it includes the quasi-stagnation of activity in the first quarter.
Surprisingly resilient underlying inflation
On closer inspection, none of these arguments allowed us to conclude that inflation was on the way to being brought under control: the virtual stagnation of activity is rather a sign of resilience, including inflation, knowing that the experts were expecting a decline; eurozone banks hardly need monetary policy support knowing that they are safer than average US banks whose current concerns reveal a gaping hole in US regulation that does not exist in Europe; moreover, to deal with the risks of bank panic, if there is stress, the ECB has a more effective instrument than its refinancing rate: “quantitative easing”; as for the tightening of credit conditions, this is nothing new and is a continuation of the previous quarter; the losses in purchasing power of wages are above all consistent with the decline in hourly labor productivity and reveal a level of indexation, admittedly partial, but excessive in relation to the inflation target of 2%; inflation is falling but core inflation remains surprisingly resilient, at a level three times higher than this target!
It’s hard to say that the conditions for a rate hike weren’t met. The ECB should therefore continue to raise its rates, which it did but by slowing its rate of increase from 50 to 25 basis points, thereby signaling its desire to navigate as closely as possible to the economic situation. It would be excessive to interpret it as a signal of an upcoming break. The battle once morest inflation is far from won. And, how might it be with real ECB interest rates that are negative or, at best, marginally positive depending on whether current inflation or expected inflation is used… when those of the Federal Reserve are largely positive, 200 to 250 basis points higher than those of the ECB?
Knowing that economists consider that the neutral real monetary rate, which stabilizes inflation, is located within the Euro zone around 100 basis points below that of the United States, we can conjecture that, barring an accident, it There is still a minimum of 100 to 150 basis points of interest rate increases to be decided by the ECB in the coming months, which corresponds approximately to the current expectations of the financial markets. And, we cannot rule out that more is needed, depending on the resilience of inflation and what the Federal Reserve will do.
The budgetary origin of inflation
This resilience might nevertheless raise questions regarding the ability of central banks to bring inflation down to 2%. Some experts argue that it might be explained by the pressure of profits and margins, beyond the control of central bankers. However, we do not see any tangible signs of this pressure within the euro zone, neither at the level of the sharing of value added which has returned to its pre-COVID level, nor at the level of the breakdown of unit prices.
More serious is the argument of the budgetary origin of inflation: inflation would correspond to a rational reaction of the market faced with the effective drift of public debts which flirt with the risk of “unsustainability” and that a level of Higher inflation makes ex ante sustainable in market expectations. In this hypothesis, the central banks would more or less lose control of inflation… hence the importance of quickly regaining control of our public finances, particularly in France where the downgrading of the rating of our public debt by the Fitch agency points to a sustainability problem… to be dealt with while there is still time.
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