Should the strongly increased inflation rate solidify in the coming year, the zero and negative interest rates of the European Central Bank (ECB) could become a “political time bomb”, warns Norbert F. Tofall, senior research analyst at the Flossbach think tank of the Storch Research Institute. Unlike the ECB, Tofall does not calculate either, which is why strong tensions in the euro area could soon break out.
The ECB recently admitted: Although the increased inflation would last longer than expected, it will fall again in the coming year. An optimistic forecast, but the ECB has good reasons to be optimistic – in its own interest. Should prices continue to rise in 2022, contrary to what the ECB had forecast, the ECB would have serious difficulties in credibly justifying its current measures.
The ECB officially justifies its policy with the inflation target. Accordingly, it is aiming for an annual rate of price increase of two percent. Critical observers have long doubted that the ECB’s monetary policy is actually about the level of inflation. But now that inflation is rising to new heights, this justification threatens to become completely implausible. If inflation continues to rise, the ECB would have to raise interest rates and end its bond purchase programs. But she shouldn’t do that, says Tofall.
In its last meeting, the ECB left key interest rates unchanged at their low level and continued to see the need for its bond purchase programs. So it continued its ultra-loose monetary policy unchanged. The inflation rate in the euro area was 3.4 percent in September and 4.1 percent in Germany. This year it could rise to over 5 percent in Germany. So if, contrary to the ECB’s assessment, the inflation rate does not fall in the coming year, will the ECB “really raise key interest rates significantly and to a level so that one can speak of an interest rate turnaround that deserves this name?” Asks Tofall . Answer: “Hardly.” The ECB will allow significantly higher inflation rates for as long as possible rather than increasing interest rates, because that would put the entire euro zone under pressure – which brings us to the core of the ECB’s monetary policy, which it has not yet addressed.
Norbert Tofall emphasizes: “Even moderate rate hikes could immediately burden the debt sustainability of most EU member states. And a turnaround in interest rates, which deserves the name, could even blow the debt sustainability of some EU member states such as Italy. It is obvious that an Italian national bankruptcy would have repercussions on the entire eurozone. The ECB has done everything in recent years to prevent Italy from breaking out of the euro zone. But France’s debt sustainability would also be enormously burdened with moderate rate hikes. “
The EU would then be spared an Italian national bankruptcy, but the ECB’s approach still harbors political risks, as the analyst emphasizes. “On the one hand, the whitewashing of the inflation outlook reduces the credibility of the ECB.” The talk of an annual price increase averaging two percent would be obsolete and ultimately implausible. But that’s not the only risk, as Tofall notes.
The willingness to accept higher inflation rates is in fact very different in the EU member states: “The previous differences in interests between the fiscally more solid northern euro countries and the fiscally less solid southern euro countries are likely to increase.” Threats to exit the euro could soon be part of daily politics again. Right-wing and left-wing populist parties are likely to gain new influx and tensions within the euro zone will continue to grow. “Inflation is likely to be the main driver of this development.”
In contrast to the ECB, Tofall believes that inflation will solidify as more likely. In order to avoid yellow vest protests like in France, massive market interventions should soon be undertaken because of the high energy prices. But above all: “When inflation is very low, then zero and negative interest rates are annoying for people. But if inflation rises significantly over longer periods of time, then zero and negative interest rates can become a political time bomb in the individual EU member states. The high inflation rates are not yet a game changer for the ECB, but politically the game in the EU could change faster than the ECB would like. “
The ultra-loose monetary policy of the ECB only recently received sharp criticism in Austria from Finance Minister Gernot Blümel (ÖVP): “Some EU states have so high debts that they cannot handle higher interest rates. The accusation is not unjustified that the ECB is not increasing interest rates because of these states. But that would be treason to the Europeans. “