Inflation and skyrocketing prices are not just a problem in the United States. Things have gotten so bad in Europe that the perpetually dovish European Central Bank (ECB) has been forced to turn warmongering.
But not really. Just hawkish for the ECB.
Last week, the ECB raised its interest rates for the first time since 2011. The bank surprised the markets by raising all its key rates by 50 basis points. This pushes his deposit rate up to -zero.
ECB President Christine Lagarde underlined the bank’s commitment to 2% inflation and indicated that further rate hikes would follow.
The ECB entered the world of negative interest rates in mid-2014 and kept the deposit rate below zero for almost 8 years.
After decades of easy money, the ECB is unsurprisingly (if you understand monetary policy) in the grip of soaring prices. In the 19 eurozone countries, the CPI hit 8.6% in June and looks set to reach double digits. The situation is even worse when looking at individual eurozone countries. Nine out of 19 Member States already report a CPI of 10% or more, surpassing Estonia at 22%.
This is the direct result of more than a decade of the ECB’s easy money policy. WolfStreet called the European bank “the most reckless central bank among developed economies” because of its willingness to sit on a policy of “silly” negative interest rates and continue printing money “even then that inflation was raging and exploding and spiraling out of control”.
Most other major central banks have already taken steps to tighten monetary policy, including the Federal Reserve, Bank of Canada, Bank of England and Swiss National Bank. Japan remains a major hurdle, with the Bank of Japan actually doubling down on easy money.
While the mainstream might call the ECB a “hawkish” move, that’s obviously not in the grand scheme of things. Zero percent interest rates can hardly be called restrictive monetary policy. As Ryan McMaken of the Mises Institute put it, “With the policy interest rate just back to zero, what the ECB is doing is not ‘normalising’”.
And on top of that, the ECB plans to continue quantitative easing, renamed the “Transmission Protection Instrument” (TPI).
The current mechanism of the TPI remains murky, but in reality the ECB will continue to buy bonds from individual Eurozone members in order to protect them from a sovereign debt crisis. For example, the ECB could buy Greek bonds in order to support Greek debt. Indeed, the bank will print euros to buy Greek bonds.
Keep in mind that Eurozone countries cannot print money. They ceded this privilege to the ECB. This means that they are at the mercy of the market to finance their individual expenses. As WolfStreet explained, “One way for the monetary union to break up would be for a fiscally ‘weaker’ country, such as Greece, Italy or Spain, to lose market confidence and face soaring yields. on its sovereign debt, where these countries are struggling to borrow new money to pay off maturing debt and finance current deficits and interest payments, while yields on German debt would remain relatively low.
The only official mandate of the ECB is to keep inflation at 2%. But it pursues a stealth mandate of maintaining spreads between bond yields in various eurozone countries. It is necessary to maintain the cohesion of the union. To this end, the ECB will buy Greek, Spanish and Italian debt to artificially reduce their yields and keep the spread between these weaker countries and stronger countries like Germany small enough to avoid unrest.
As one analyst at Yahoo Finance said, it really doesn’t make sense.
Quantitative easing is easing and rate hikes are tightening. They are basically trying to do two things at the same time.
In his podcast, Peter Schiff said there was no way for the ECB to meet its inflation target and limit these yield spreads.
If the ECB really wants to fight inflation, then it cannot do this asset purchase program. He will have to keep raising interest rates, which means countries like Italy will have to pay much higher interest when they borrow money than a country like Germany. Now, there is no way around this. Lagarde wants to pretend they have a way to control the spread, but in reality that can’t be done. If they want to hit their inflation target, there’s no way that will happen if they keep printing money to buy Italian bonds, or Spanish bonds, or Greek bonds. They’re going to have to pull out of quantitative easing.
McMaken argued that even with rising rates and talk of further interest rate increases in the future, “not much has really changed at all.”
The ECB seems to be taking a page out of the Fed’s playbook by trying some of the weakest measures of monetary tightening and simply hoping against hope that it will rein in price inflation without causing a painful recession. This approach, however, is likely to put the ECB even further behind the curve to fight price inflation fueled by vast amounts of monetary inflation employed to prevent an economic implosion during the covid shutdowns.
And of course, as McMaken alludes to, with this sudden tightening of monetary policy, Europe will now face the same problem as the United States – the potential for a deep recession.
It will be interesting to see how these ECB moves will impact the dollar. With the Fed tightening earlier, the dollar strengthened significantly against the euro. Earlier this month, the dollar reached parity with the European currency. If the ECB continues to tighten, we could see relative dollar weakness. Schiff said he thinks we could see short-term bond yields in the euro zone higher than in the United States by the end of the year.
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