“Inflation will remain undesirably high for some time,” warned European Central Bank President Christine Lagarde. Already weakened by the crisis triggered by the Covid-19 pandemic, the economic situation hanging over the continent has worsened with the Russian invasion of Ukraine. The ECB is worried. While dismissing the prospect of a recession, it lowered its growth forecast to 2.8% for 2022 and 2.1% for 2023.
The shortage of raw materials should contribute to the continued rise in energy and raw material prices, warns the institution. Economic activity will rebound, however, “when the current headwinds ease,” the central bank added. Fiscal support coupled with savings that should be released after being accumulated during the pandemic should contribute to the improvement.
Faced with a context that the institution considers risky, the central bank is on the way to carrying out the opposite policy to that which it had initiated several years ago. She announced the interruption of net asset buybacks “as of July 1”. Bond buybacks, which flooded the market with liquidity, were launched in 2015 to combat the hydra of deflation, considered to be poison for the economy. In short, the central bank systematically bought up securities and debts to lower financing costs and thus revive the economy.
But since then, the economy is picking up too strong, too fast. The ECB is faced with the opposite challenge: bringing down inflation and reducing prices. Debt buybacks should therefore be suspended. The new European policy should be accompanied by a rise in rates from July, which it had not done since May 2011. The priority is to quickly emerge from the era of negative rates, inaugurated in 2014 with the rate on bank deposits, currently set at -0.5%. It hits some of the dormant cash at the central bank to induce commercial banks to distribute more credit to help the economy.
But the risk associated with the end of asset purchases is to see the gaps between the borrowing rates of the so-called fragile countries of the euro zone and those considered “safe” widen. Behind these differences, the idea is that the market demands a higher risk premium to finance countries in the euro zone whose public debt, inflated with the Covid-19 crisis, is at the limit of bearable. The effects of central bank policy could therefore be immediate.
