ECB’S RATE HIKE PLAN FACES POLITICAL DISCORD

The 25 members of the European Central Bank’s (ECB’s) governing council that sets interest rates thought they were ready to flip the switch on their well-publicized quarter-point rate hike this month.

“They were wrong,” the Financial Times reported.

The problem: borrowing costs have risen for European Union countries with feeble economies, especially Italy, leading to a widening spread between loan rates for countries doing well and those still struggling, a problem called “fragmentation.”

For example, the difference in yields between Germany’s 10-year bond and that of Italy widened recently from one point to two.

Italy’s national debt now exceeds the amount it owed during the Great Recession. A higher interest rate could lock the country into “an unsustainable spiral of rising debt costs,” the Financial Times said.

The problem is worsened by varying fiscal policies among the Eurozone’s 19 member countries, leading to differing borrowing costs.

Raising the ECB’s interest rate likely would widen the spread, drawing investment away from member countries with weaker economies and channeling funds to those doing better.

The council has convened an emergency meeting to design an “anti-fragmentation instrument” to ensure that lagging countries are not disadvantaged by the central bank’s forthcoming rate boost.

The “instrument” probably will be a commitment by the ECB to buy the bonds of countries incurring borrowing costs that carry a risk premium, or higher interest rate than is justified by fundamentals, according to the FT.

“The difficulty will be in the gray zone between what is warranted and what is not,” Pierre Wunsch, governor of Belgium’s central bank. “That is the area of moral hazard that we have to navigate.”

The aid will need “sufficient safeguards to preserve the impetus of member states toward a sound fiscal policy,” ECB president Christine Lagarde said in a recent public statement.

“We need countries to make an effort,” Wunsch said.

Countries needing help may be told to formulate a medium-term plan for financial stability and agree to have their finances monitored by the European Commission (EU).

“Otherwise, the [ECB] is steering governments on fiscal policy, which is not what it wants,” Carsten Brzeski, ING’s head of macro research, told the FT.

Germany and the Netherlands, two of the ECB’s fiscal hawks, are reluctant to back the plan, worrying that it will cause troubled nations to not do the hard work of righting their finances or that the bank could wander into “the monetary financing” of governments, which would contravene the EU’s founding treaty.

The ECB’s previous bond-buying scheme was challenged more than once in Germany’s constitutional court and the new plan likely would have to navigate the same complaints, the FT noted.

TREND FORECAST: With inflation spiking in Europe to 8.6 percent and the ECB claiming for a decade that if inflation hit 2 percent they would raise rates, the ECB is constrained by the mental disorders of  various members of the bank that refuse to take strong enough actions.  

The ECB continues to err on the side of protecting the economy by making small, incremental rate increases that will have virtually no impact on inflation’s rate and maintaining a too-loose monetary policy.

The European Central Bank is raising rates far too late to have any material impact on inflation in the near term, if not longer.

Bullshit Has Its Own Sound

While inflation alarms were blasting, ECB President Christine Lagarde, president of the European Central Bank (ECB) ignored them and belittled those who sounded the warnings.

This past January, Lagarde once again rejected calls for the bank to raise its base interest rate from its current -0.50 percent, where it has remained since 2014. (See “ECB: More Monetary Methadone,” 27 Apr 2021 and “ECB Pledges to Keep Rates Lower Longer,” 27 Jul 2021.