The media have made a mistake in judging the monetary policy of the European Central Bank (ECB). Headlines pointed out that last Thursday’s 75 basis point hike was the largest in history and an unprecedented move, hinting that it was a once-in-a-lifetime decision. And it is not like that.
The climb fell short. There are several clues in the words of ECB President Christine Lagarde and in the data she provided that point in that direction. Lagarde raised the eurozone inflation forecast for this year and next year from 6.8 to 8.1 and from 3.5 to 5.5, respectively, while admitting that there were up to five price increases left of money.
The goal of flattening the inflation curve will not be achieved until well into 2024, when prices should close at an average of 2.3%. We have two years left in which the types will only get more expensive. Compliance with the objective on price stability is thus delayed by one year. This is the first conclusion.
Lagarde’s second message was that Europe is already in stagflation (high inflation without growth) and will enter a recession in the first quarter of next year at the latest. Eurozone growth for next year cut it by more than half, from 2.1 to 0.9%. And he warned that the GDP will turn negative -0.9% (1.8 points less) in the event that Russia cuts off gas. Let’s be realistic and tell the truth: Putin already cut off the gas a few weeks ago. Two threads remain, running through Turkey and Ukraine, accounting for about ten percent of the entire flow. Largarde used a condition to hide the reality, that the eurozone will enter a recession next year.
His speech can be summed up as follows: the crisis will be long and worse than it seemed. He has only just begun and very painful measures will have to be taken in the next two years.
So why did the financial markets react positively? Above all, the banks, which posted increases close to ten% in two days, in some cases. Because rates are expected to double from their current level. In addition, the ECB did not reduce the balance of its debt purchases or the injections of liquidity to financial entities so that they lend to their clients, the so-called LTROs. (Long Term Refinancing Operation).
Banks will experience an ideal situation in the coming months, since the ECB maintains liquidity auctions under the same terms, aimed at facilitating financing for companies and families. But with the advantage that these loans will now charge more expensive.
Liquidity auctions were essential during the years 2011 and 2012, with the relapse of the economy, as well as during the Covid. This crisis will be harder than the pandemic, because on that occasion the increase in public spending to maintain consumption was made at zero rate. Now the price of money will be more expensive. Here is another aspect that is of great concern to the ECB: the public debt of its member states.
As Sánchez explained in his debate with Feijóo last Tuesday, the Government reacted, like the rest of Europe, by launching a citizen protection mechanism, basically through public aid. The president evaluated at 30,000 million, almost three points of GDP, the cost of the royal decrees, which contain popular measures such as the discount of twenty cents on fuel, free public transport or the reduction of taxes on electricity and gas, among others.
Chancellor Scholz announced last weekend a package of 64,000 million in aid to students and households to spend the winter, which raises the sum of public money allocated by the German State to more than 90,000 million. France or Italy have also triggered their indebtedness, despite the fact that they are on the verge of the allowed limit. In the case of Italy, its public debt represents more than 1.5 times its GDP, that is, everything it produces for a year and a half.
The aid is not aimed at the most vulnerable or at strengthening the industry, but rather is granted indiscriminately to the entire population, probably for electoral reasons. Sánchez has elections in just over a year, while Scholz’s popularity is hovering at historic lows.
The latest surprise came from the new British Prime Minister, Liz Truss, who will freeze gas and electricity, while keeping the 500 euro check promised by her predecessor for the next two years, just the time left for her re-election. . The cost will be close to 115,000 million pounds and will place the debt / GDP ratio of the United Kingdom above one hundred percent.
All this exuberance of public spending, when we have not yet met the onerous costs of the pandemic, poses a problem for central banks: it forces them to raise the price of money to refinance debts. In the UK, rates are expected to end at 3% by the end of the year and in the euro zone at 2.5%. And it is another reason why the ECB delays the recovery.
Lagarde maintained the public debt purchase bazooka. In recent years he has acquired around five billion in public titles. When he announces his final retirement, the markets are going to get very nervous and the yields of some government bonds will go through the roof. Difficult times lie ahead.
I remind you that the ECB was forced to approve a few months ago an instrument to protect speculative attacks on the debt of peripheral countries such as Italy, Greece or Spain, called TPI (Transmission Protection Instrument). An initiative that will force these countries to adopt austerity measures and will slow down their activity.
The main element of concern for central bankers is the price of energy, mainly gas. If the pandemic caused a rapprochement between the 27 when it comes to administering vaccines or helping the most vulnerable countries, Putin’s war has divided them.
Measures such as the cap on Russian gas will not go ahead because countries like Estonia, the Czech Republic or Germany are against it while the vast majority are in favor. The same goes for sanctions, after Putin threatened to cut off all supplies if they are upheld. The European Commission must renew them in the coming days.
The measures approved this Friday by the European Council, such as capping the price of renewables, will help contain electricity, but in no case will it reduce its price. Germany is making a great effort to diversify its energy sources, but the most optimistic forecasts suggest that it will run out of gas to satisfy all its consumption in the spring of next year. And from that moment, what will happen? Nobody knows. I don’t want to imagine what the winter of 2023 will be like if Putin keeps the tap turned off.
For this reason, the ECB prefers not to give details about its growth forecasts beyond the first quarter of next year. Putin has won the gas war, the sooner we admit it, the sooner we will find solutions to our problems. But probably he will lose the war with Ukraine. Zelensky’s army is retaking key cities like Kharkov. He urges the opening of talks to end the conflict and the economic disaster that is looming in the coming months.
PS.-The President of the Government and his third vice-president, Teresa Ribera, have been disappointed. The EU refused to adopt the Iberian exception, as well as a special tax on energy. Sánchez even boasted in the Senate debate that other countries would copy him, but he slipped in once again.
Who is also wrong is the second vice president, Yolanda Díaz, by forcing the creation of a shopping basket with thirty products at cost price. We already know how these things work. Large stores will force their distributors to lower prices, even at the cost of incurring losses, in order to maintain the sales channel. Small business will be the big loser. Before opening his mouth, Díaz should spend a couple of afternoons learning how the market economy works.
