Christine Lagarde admits her “error” of having badly anticipated inflation, which will remain high.
The European Central Bank knows that it is playing its credibility and that of the euro. The Frankfurt institution intends to show unfailing determination to fight forcefully against inflation. After having raised, for the first time in eleven years, its key rates by 0.50 points in July, it increased them again by 0.75 points on Thursday. The deposit rate, which has been negative for eight years, is now at 0.75%. And it’s not over.
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“We still have a long way to go “Warns Christine Lagarde, President of the ECB, hinting at a series of rate hikes which will be “more than two” but probably “less than five “. One way to let the markets guess the extent of the increase in key rates at the end of the year. The pace of this monetary tightening remains to be seen. Increases of 0.75 points, very fashionable among the major central banks (Fed, Bank of England, Bank of Canada), not being the “ standards ».
The decision to make such a historic shift (unprecedented except for the creation of the euro in 1999) was taken unanimously by the twenty-five members of the Board of Governors, who met on Thursday during a discussion “cordial, efficient and profound “, according to Christine Lagarde. The rare voices who were worried about the risks for the economy of a too rapid recovery therefore rallied to the consensus that it is inflation that presents the greatest danger.
“Credibility”
“Given that we are so far from the rate that will allow us to return to our inflation target of 2%, our hikes must be timely and of sufficient magnitude,”justifies Christine Lagarde .It does not excludeto “go further” than expected, if necessary. “Our credibility will be judged on whether or not we bring inflation back to the 2% target,”adds the President of the ECB.
We are far from it. After 9.1% in August, the rise in prices in the euro zone should continue to increase in the coming months. Energy prices jumped 38% and food prices 10.6%. More worryingly, this rise has started to spread to goods and services.
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As a result, ECB economists revised their projections upwards. They now expect 8.1% inflation on average over this year, 5.5% in 2023 and 2.3% in 2024. The mission to tame it would therefore not be accomplished within two years. In this regard, Christine Lagarde assumes the “responsibility” of the “forecast errorsof the institution, which led her to be slow to react, adding that “all forecasters have made this mistake».
At the same time, due to rising prices and threats to energy supplies, the ECB expects the economy to slow down by the end of the year. It anticipates a “stagnation” of GDP in the fourth quarter of 2022 and the first quarter of 2023. Its new forecasts call for growth of only 0.9% for the euro zone in 2023, revised sharply downwards from 2.1% previously expected.
The euro down
Given its influence on the markets, the ECB can hardly announce a recession, at the risk of favoring its arrival. But a more pessimistic scenario of forecasts still foresees the possibility of a contraction of GDP by 0.9% in 2023. A war in Ukraine which would drag on would weigh on confidence, would continue to push up the costs of energy and disrupt supply chains.
Conversely, according to Positive Money, this decision is a“major policy error” because she is “unjustified, unfair and risks slowing down the green transition, and is unlikely to lower the price level».
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For the time being, the ECB has not ventured into the next stage of monetary tightening, which would consist in reducing the size of its balance sheet, after years of buying back liquidity on the markets. A measure already announced by the US Federal Reserve, which would risk tightening borrowing conditions a little more for the most indebted states, such as Italy or France.
The euro reacted by continuing to fall, to -0.48% in the afternoon, still below the dollar threshold. The ECB does not “set a target” for the exchange rate of the single currency but “watch closely» its evolution, which weighs heavily in inflation.
Eurozone banks spared by the Central Bank
Some observers expected the ECB to encourage banks to prepay some of the highly advantageous loans (so-called “TLTROs”) that it extended to them during the pandemic. To encourage them to finance businesses and households, the Central Bank lent them money at negative rates of up to -1%. “The maximum negative rate represented a huge subsidy to the banks of 1.83 billion euros,” underlines Eric Dor, director of economic studies at Iéseg. They were paid to borrow from the Eurosystem. »
At the end of June, the rate of these loans was modified. “But establishments always have an interest in keeping their loans until they mature,” says Eric Dor.
If it had pushed financial institutions in the euro zone to repay these giant loans (2,263 billion euros in total outstandings), the ECB could have reduced excess liquidity in the markets and reduced the size of its balance sheet. Like what the US Federal Reserve does. But, the Frankfurt institution preferred to play it safe. “High inflation and the risk of recession pose a risk of credit default on banks, says the economist. And some may find it difficult to cope. »