After the United States learned to raise interest rates in the economy unusually quickly and sharply, it seems that the Europeans now understand – and belatedly, as usual – that they must take a similar approach quickly and perhaps even more aggressively.
The vice president of the European Central Bank, Luis de Guindos, says that the main risk to the “spiral” in wage prices is the perception that the credibility of the central bank is not strong enough. “That is why we commit to price stability… and that we will do everything necessary to reduce inflation to a level we consider to be price stability, which is 2%,” he said. Wages in the Eurozone have risen but not yet at an “excessive” pace, he added. However, he emphasized that the lesson from the stagflation seen in the 1970s is that monetary policy should be focused on to avoid negative effects afterwards.
Eurozone inflation is at 10.7%, the highest level in the bloc’s history, and the ECB raised its interest rate to 1.5%, a level not seen since 2009, before the debt crisis. De Guindos said he could not say what the final rate of the ECB interest rate would be, although the markets “require guidance”, but the central bank should have “said very clearly that we are going to do our job, that we will lower inflation, and that we will raise interest rates to a level that is compatible the convergence of inflation to define our price stability”.
The ECB published a financial stability review that outlined the challenges facing businesses and households in light of the poor economic outlook, high inflation and monetary tightening. He argues that governments should provide vulnerable sectors with targeted support without interfering with the normalization of monetary policy. At the same time, economists predict that the Eurozone is headed for a deep recession against the backdrop of falling consumer confidence.
De Guindos said that banks must be “cautious and prudent, avoid a short-term increase in profitability due to higher interest rates, and prepare for the near-term potential increase in insolvencies and reduced repayment capacity of households. The tight labor market, with unemployment at an all-time low, has been a positive factor – but it is not guaranteed that it will continue in the future,” he continued. However, he downplayed the risks of a split in the eurozone that could lead to another debt crisis, noting that spreads between government bonds had not widened significantly. He also said that eurozone countries had not seen “the kind of accidents we saw in Britain with the mini-budget”. And he hoped that wouldn’t happen either.
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A series of unfunded tax cuts and pro-growth measures announced by former UK Prime Minister Liz Truss – which came as the Bank of England raised interest rates and was about to start selling bonds – caused sharp declines in markets and even nearly caused pension funds to collapse.
Regarding quantitative tightening, de Guindos said, “My personal opinion is that we have to be careful. It has to happen, it has to be part of the normalization process of monetary policy, but at the same time, given the potential consequences, I think we have to do it very carefully.”
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