The ECB has the mandate to ensure price stability. But despite high inflation, it is only hesitant to exit its expansive monetary policy. Why is that.
It’s not a nice situation for the European Central Bank (ECB). Inflation is high, and the monetary authorities would actually have to raise interest rates in order to bring them closer to the target of two percent. But the economy is sputtering from the Russian attack on Ukraine, and a rate hike would further weaken the economy. Especially since the ECB can only take action against imported inflation – so far the high energy prices have been the main reason for the price increases – by slowing down the economy and thus reducing the demand for energy. The central bank cannot intervene directly on energy prices.
If the ECB does not raise interest rates, inflation in the euro area threatens to solidify through second and third round effects. Once the expectation of rising prices is firmly entrenched in the minds of market participants, they will try to limit their own loss of prosperity. Workers are demanding big wage increases, and companies in turn are raising prices. However, if the ECB increases interest rates, the refinancing costs increase, especially for southern EU countries such as Italy or Greece. Not an easy position for the ECB, which is much more reluctant to fight inflation than the US Federal Reserve, which has already made significant interest rate hikes. Rising wages in the USA are already providing additional inflation momentum.