The ECB decides to drown the economy to end inflation

The European Central Bank (ECB) clung this Thursday to the classic manual of monetary policy. The one who says that raising reference interest rates serves to reduce inflation. In this way, he insisted on the strategy of prioritizing the fight against price increases and assuming the risk of causing a recession and higher unemployment. What it already contemplates in its worst forecast scenariowhich includes a long war in Ukraine and a gas cut, to which Spain presents more resistance than, for example, Germany.

The logic is as follows: the rise in mortgages, loans and financing in general reduces consumption, business investment and the State's spending capacity. Or what is the same, rate increases cool activity and prices should stop rising.

Background risk is crueler. A recession with consequences greater than a simple braking. Taken to the extreme, it is choosing between having controlled inflation but taking unemployment to 25% – a level that could be reached in Spain in a crisis according to historical data. Or suffer inflation, with the corresponding damage to purchasing power, but with much lower unemployment.

According to the formula chosen by the governing council of the institution, its president, Christine Lagarde, announced this Thursday an increase in interest rates of 0.75%, the largest in the history of the eurozone, up to 1.25%. Another increase after the first in July of 0.5%, from the 0% at which rates had been maintained for years to favor the exit of the Great Financial Crisis of 2008, first, and to overcome the shock of the COVID, after. And he announced that he will continue to raise them in the coming months, without specifying how much or when, under a continuous analysis of the context, at the pace of "meeting by meeting."

Different market sources point to another rise of 0.75% in October, plus another equal in December, and a last rise of 25 basis points in February 2023. Expectations that are made based on the trends observed in the financial markets, where the prices of the debt of the countries, such as those of Germany, France or Spain, anticipate the ECB's decisions on interest rates.

The Euribor is also quoted, the benchmark index for calculating mortgage payments in the eurozone, which serves well as an example (see chart). Since December 2021, it has risen about 2.5%, to close to 2% today. That is to say, its evolution doubles the 1.25% of the official interest rates, and, today, it expects another 1.25% increase by the ECB, although it can be foreseen that it will continue to rise according to the estimates that are handled , before the aggressiveness shown by Lagarde.

Some numbers that arise as a result of the ECB's decisions are the following: "The minimum annual increases [en 2022] for mortgages that are reviewed imminently, they already comfortably exceed 1,300 euros, on average," calculates Asufin (Association of financial users) for a loan on a typical home (from 100,000 euros to 25 years).

"According to the forecast we handle, until the monthly data is confirmed, which is used to review mortgages, the Euribor will stand at 2.2% at the end of the year, which means that family loans will become 130 euros per month, and more than 1,500 euros per year. If this trend continues, it is possible that we will already reach 3 percentage points of Euribor by 2023. This translates into mortgage increases that could already exceed 2,000 euros, taking as a reference a standard loan of 100,000 euros, 25 years", they conclude from the association.

This increase in mortgage prices can be transferred to the rest of the loans, those that companies need to finance their activity or to the debt issued by the State to finance the expenditure that exceeds the income each year.

The strategy chosen by the ECB tries to "a balance that is not easy to find"as admitted this Thursday by sources from the Ministry of Economic Affairs, which is directed by the first vice president Nadia Calviño.

The less orthodox experts are more incisive and present different criticisms of the ECB's decisions. The first is that the origin of this inflation crisis has its origin in energy. The second is that this same price crisis for oil, natural gas and other raw materials was exacerbated by the Russian invasion of Ukraine.

Neither crude oil nor gas will respond to a tightening of financing conditions. Ultimately, they will react to sinking demand, if the recession deepens, but even that will not prevent the threat of gas flow cutoffs from Russia or production cutbacks by the dictatorships that produce most of the oil. Much less will a rise in rates affect the war, a humanitarian and geopolitical issue.

Finally, "the decision comes while the indicators show growing risks of recession, and while people see how their real incomes are drastically reduced," they recall from Positive Money Europe.

Indeed, the energy crisis itself and the uncertainty due to the war have already chilled the eurozone economy, so "the ECB's decision is unjustified, unfair and risks slowing down the green transition, and is unlikely to reduce prices", continues the team of economists of this non-profit organization based in Brussels. "Again, it will disproportionately affect low-income households who already have higher bills to pay."

Thus, the ECB's policy ignores the origin of the inflation crisis in energy and geopolitics, which have little to do with financing conditions. And it is added to the end of the debt purchase programs with which it has created money to guarantee demand in the financial markets for years and precisely enhance growth and economic recovery.

Yes, there is some consensus that the best reason (or the only one) to raise official interest rates is the sinking of the euro at its crossroads with the dollar, to which Lagarde herself referred this Thursday.

It is because the United States Federal Reserve (Fed) has been effectively more aggressive than the ECB in recent months, turning the dollar into a vacuum of money in international markets. This policy has caused the return offered by the debt denominated in the greenback to rise sharply, as a result of the rise in interest rates on the other side of the Atlantic, where they are already at 2.25%.

The weakness of the common currency, which has depreciated 20% against the dollar since the first days of 2021, translates into cheaper exports [lo que se vende fuera], but also in a higher price of imports. And the most important bills paid by the eurozone states in dollars are for energy raw materials, already skyrocketing.

“The best way to see how much things have changed is through the eurozone trade balance, which, after years of surplus [se vendía más de lo que se compraba fuera]it now has a deep deficit,” says Robin Brooks, chief economist at the IIF.

"The weakness of the euro and the deterioration of the trade balance in the eurozone only makes the problem worse, since it pulls inflation up by increasing the bill for imports," admits Mark Nash, an expert at the manager Jupiter AM.

From an aggressive cycle of interest rate hikes by the ECB, it can also be understood that there is confidence in the strength of the eurozone economies, even that a debt crisis and increases in risk premiums like the one in 2010 and 2012 is remote thanks to the totally different starting point due to the extraordinary financing conditions of recent years.

“Spain remains in a growth path despite the energy crisis, the tightening of monetary policy and the uncertainty due to the Russian invasion of Ukraine”, argued, in this line, Nadia Calviño, first vice president and minister of Economic Affairs, who influenced, this Wednesday in Congress, in the burden of public debt [lo que el Estado gasta cada en año en la factura de intereses] continues to decline even if interest rates rise.

This financial burden or interest bill on public debt remains close to 2% of GDP, far from 3.5% in 2013, and is around 5% of public revenue, well below the 9% it exceeded in those years of the euro crisis, just after the bank bailout.

Calviño insists that Spain presents clear differences with respect to other economic cycles, compared to other crises. And one of these differences is precisely the "sustainability of public finances", in the sense that paying the debt requires less effort on this occasion, after years of expansionary (and extraordinary) monetary policies that the Public Treasury has taken advantage of.

This "sustainability" is also reflected in the objective of reducing public debt below 110% of GDP, after soaring in 2020 above 120% due to "the cost of the response to the pandemic", and the measures that the energy and inflation crisis are demanding. Calviño also clung to the objective of reducing the budget imbalance, the deficit (what is spent compared to what is received), from 5% in 2022 and 3.9% in 2023.

Source link