Germany : Loss of control in Frankfurt

Posted on May 25, 2022

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Loss of control in Frankfurt

Commentary by Niklas Hoyer

May 25, 2022

Central bankers don’t have it easy: on the one hand, they should prepare the financial markets and the rest of the economy as well as possible for their forthcoming decisions so that there are no surprises. On the other hand, they must not commit themselves too much so that there is room for maneuver if the environment develops unexpectedly.

The US Federal Reserve has done this job relatively well so far. Although it was late in taking the rise in inflation seriously as a danger, it then adjusted its monetary policy at record speed. In May, it raised its key interest rate for the second time and announced further tightening at a rapid pace.

The European Central Bank (ECB) , on the other hand, with Christine Lagarde as President, has not fared so well so far. Inflation was first played down, then taken seriously – but the ECB only wants to change course slowly when it comes to monetary policy . “Gradually” is what it’s called in Frankfurt. Many see this approach as a problem: the hesitant reaction could cause inflation to get out of control. The ECB must pay particular attention to the heavily indebted southern European countries and therefore does not dare to react decisively. Inflation? I where! Or now? Isabel Schnabel’s change of heart

The closer the next ECB meeting on June 9 gets, the louder the public exchange of blows – and the greater the public confusion. It is foreseeable that the end of the ECB’s bond purchases will be decided at the June meeting. In addition, the ECB wants to prepare the markets for a rate hike in July. So far, so clear.

But everything else is then already unclear. ECB President Christine Lagarde was unusually clear in a blog post on Monday: two interest rate hikes of a quarter point each in July and September were derived from this as the ECB plan. But that annoyed all those on the Governing Council who want a quicker exit from loose monetary policy. Three central bankers have now publicly spoken out in favor of raising interest rates by half a percentage point. So is everything different?

At its core, the dispute also revolves around whether the high inflation rates in Europe are a result of the massive rise in energy prices – or whether other factors are making a significant contribution. It is also important whether the high inflation is already leading to second-round effects: such as higher wage demands, which then lead to a spiral of rising prices and wages. Depending on how you read it, the ECB can fight inflation more or less well with interest rate hikes. In other words, if only energy prices are driving inflation and there are no second-round effects, then interest rate hikes will have little effect. This is exactly what has made Lagarde so far not want to “rush into anything and not panic,” as she said at the World Economic Forum in Davos.

That sounds reassuring, but it isn’t. As long as the ECB does not find a clear course, investors must certainly consider a certain loss of control in Frankfurt.

Nicholas Hoyer

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