Sintra, Portugal — For central bankers, the world has changed suddenly. After more than a decade of low inflation and low interest rates, policy makers are now in a high inflation environment, have no time to make harsh decisions, and only take swift and decisive action.
This was a verdict between policy makers and economists who gathered at a luxury golf resort northwest of Lisbon for the European Central Bank’s annual forum this week.
Since 2014, this annual meeting in Sintra has been concerned about one key goal of how to cause inflation in the euro area.
Not this year. With the vast global supply chain turmoil, the war in Ukraine, and rising energy prices, policy makers face the opposite challenges. Inflation is the highest in decades. According to Friday’s data, the eurozone’s annual inflation rate rose to 8.6% in June, another record.
However, while there are many variables in the outlook for price increases that are beyond the control of central banks, such as the length of the war and the future of energy supply from Russia and elsewhere, the message to central bank officials is clear. did.
Panel discussions and presentations were imminent with memories of past crises, such as the global stagflation of the 1970s and the Eurosovereign crisis about 10 years ago. Like many other advanced economies, Europe is trying to avoid the trap of stagnation (a period of stagnation in economic growth and unpleasant high inflation), but will raise interest rates without panicking the government bond market finances. It is said that. More debtor countries in the region.
ECB Governor Christine Lagarde said at the opening of the forum on Monday that “monetary policy is in a difficult time” and issued a statement opposed by everyone in the room.
Over the next two days, she reiterated the central bank’s plans to raise interest rates by a quarter percentage point in July for the first time in more than a decade, and in September to raise interest rates, which are likely to be even higher. In line with the principle of “gradualism”, prices are expected to continue to rise from there.
The risk of sustained high inflation outweighed concerns that the region’s economy was slowing. Lagarde said he may not return to the world of low inflation that has dominated for decades. Inflation forces were “unleashed” by the Covid-19 pandemic and war in Ukraine, she added.
After a two-year break after meeting in person for a pandemic, A solemn message about the seriousness of the challenges faced by the central bank rushed through my mood.
Despite the heap of economic, business, and financial market data, understanding where people think inflation is heading is, to some extent, reading tea leaves. One panel discussed how difficult it is to know who inflation expectations are most useful in predicting inflation — households, businesses, or financial markets. And there was still no accurate way to know if long-term expectations exceeded the central bank’s goals. This is a dangerous situation that perpetuates high inflation.
But policy makers cannot take the risk of waiting to be discovered, Loretta J. Mester, president of the Federal Reserve Bank of Cleveland, told the audience. “Central banks need to be resolute and will take deliberate action to reduce inflation,” she added.
And these actions could be painful for people, Federal Reserve Chair Jerome H. Powell warned, and Lagarde agreed. But he said sustaining high inflation would be more painful.
The ECB has just begun to raise interest rates, a few months behind the US ECB. High inflation is a global problem, but for some time the ECB has been able to take a slower approach due to different causes of rising prices. High energy prices and global supply chain disruptions are not phenomena that banks can stop by raising interest rates. Unlike the Fed, European policy makers aren’t trying to cool the overheating economy. In Europe, consumption has not even recovered to pre-pandemic levels.
As inflation soared and banks’ own economists began to publish star car forecasts, there was an increased risk that rapid price increases would take hold. After months of division in the Governing Council, a sense of unanimity slowly emerged as a small number of raters sought quicker action.
“Looking back, I think many board members already wanted to raise rates in June,” said Frederik Du Closet, Head of Macroeconomic Research at Pictewealth Management. “But it’s a very difficult situation because we know we’re heading for a slowdown.”
But at this point, “inflation concerns outweigh everything else,” I added.
The difference from the 1970s today is that central bankers can act more aggressively and more aggressively, says Hilde C. Bjornland, a professor of economics at BI Norwegian Business School, on recent oil prices. Said in a presentation about the rise in the economy and how it weighs heavily. Affects the European economy and inflation expectations.
“It requires quick action from the central bank, and it now needs this quick action,” she said.
What hasn’t changed since the establishment of the central bank is that it maintains a monetary union (Eurozone) without supporting the infrastructure of financial, banking and capital union markets.
One policy must be provided for 19 economies. Inflation rates in June ranged from 6.1% in Malta to 22% in Estonia.
“This is one of the issues that the Eurozone and the European Union need to address,” said Martins Kazaks, Latvian central bank governor with inflation reaching 19%. “The institutional architecture of the Eurozone and the European Union is by no means perfect.” Fiscal policy needs to intervene and provide support to the most vulnerable, but unlike pandemic support programs, it has a targeted deadline. Need to be provided, I added.
“In the current situation, if inflation is very high, monetary policy needs to address the issue of inflation,” he said. He “doesn’t go as far as fiscal policy,” he said. He suggested that the July rate hike may need to be higher than the quarter point currently reported in the telegram. Gradualism “does not mean slow,” the Kazakhs said.
The ECB needs to fight this inflation problem while avoiding another crisis. There is a risk that the cost of borrowing in a financially weak economy will skyrocket due to rising interest rates and the termination of large bond purchase programs. In mid-June, Italy’s 10-year government bond yields exceeded 4% for the first time since 2014, and the gap with Germany’s borrowing costs, the region’s benchmark, is widest since early 2020, when the pandemic devastated financial markets. rice field.
Central banks buy other bonds using reinvestment from bonds that mature in a € 1.85 trillion ($ 1.9 trillion) pandemic-era bond purchase program in response to widening borrowing cost inequality. , Announced to avoid it. It is called market fragmentation, which can disrupt the effectiveness of monetary policy. Banks will also accelerate the design of new policy tools to address the issue, Lagarde said.
New tools need to pay attention to the legal and political challenges that they may face. Ten years ago, the central bank sought to design a policy tool that was in line with Mario Draghi’s commitment to “do whatever it needed” to save the euro.
As a result of efforts, a program will allow central banks to purchase unlimited amounts of debt in markets issued by needy countries, provided that independent institutions are part of a formal bailout program to implement economic reforms. Was born. This initiative faced legal and political conflicts, but in the end, the announcement of this tool was sufficient to calm investors in the bond market.
It has never been used.
The volatility of today’s bond markets is not so severe that new tools are not expected to be offered in such harsh conditions. However, banks need to carefully design their tools so that they do not send the misleading message of tightening monetary policy with one hand and easing monetary policy with the other.
But this challenge does not interfere with what Lagarde currently presents as a clear-eyed and single-focus vision of tackling inflation.
“We address all obstacles that could threaten our price stability mission,” she said. “we will.”