Christine Lagarde, President of the ECB.


Christine Lagarde, President of the ECB.
Christine Lagarde, President of the ECB.Getty Images

This week another key meeting of the European Central Bank. It happens in a context of higher and more persistent inflation and renewed messages from those responsible. Now they openly talk about several interest rate hikes. It seems that it will be in July when the first increase in official rates will take place. However, many questions arise. The first of them is palpable, the reaction of investors and the behavior of rates in the market have not waited for the ECB’s decisions. They have been rising for months, also those of sovereign bonds, with a takeoff in risk premiums.

Another concern is how far central banks, particularly the ECB, will go to control inflation. If a few increases will be enough to lower price growth or if more will be necessary already in 2023, if inflation continues to worsen. This second scenario, clearly more negative, could lead us to a recession, since interest rates would have to be raised enough to control inflation. As a large part of the rise in prices is explained by the supply and cost side, monetary policy may be less effective there. Even so, central banks will have no choice but to raise rates to prevent lasting inflationary expectations from becoming anchored among economic agents.

Separate chapter for sovereign debt. The great tie for the central banks, but especially for the ECB since 2012. It is already being noticed, especially in the Italian and Greek risk premiums, but also the Spanish and Portuguese ones, in a framework of generalized growth of the debt returns. It supposes an increase of the financial costs for the States. There is talk these days that the ECB is designing the mechanism to prevent the risk premiums and financial costs of the most vulnerable countries from running amok. Soon we will know more details. We are in time to avoid a financial fragmentation in the Eurozone like that of 2010-2012.

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In any case, it would be good if this mechanism were associated with a strong commitment on the part of Brussels and member countries with the recovery of a path of credible fiscal adjustment. Monetizing public deficits is not a good idea. It is going to require a good job from Frankfurt, Brussels and the national governments. This mechanism must be compatible with the fight against inflation and it cannot be forgotten that here it may be necessary to do a “whatever it takes” —emulating Draghi—, but now the other way around, raising official rates and tightening monetary measures until the inflation shocks.

In a positive interpretation, it is possible that the return to higher yields could make the European economy, which in recent decades has attracted less interest among investors, more attractive. The changes of recent months in the global order may be a new opportunity to increase the economic incentives of Europe, which now does seem to act as a unit. There are tough tasks for everyone, but the role of the ECB and its credibility will be very important.

He knows in depth all the sides of the coin.

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