The ECB Can’t Justify What It Is Doing


As the European Central Bank announced the most aggressive tightening of monetary policy in its recent history Thursday, it added the usual statement that “future policy rate decisions will continue to be data-dependent.” But it seems happy to ignore most of the data.

ECB President

Christine Lagarde

said interest rates would rise to 0.75% from zero, responding to eurozone inflation hitting 9.1% in August. But the central bank also slashed its projection for the economy, which many analysts think is on the brink of recession due to the current energy crisis.

The ECB thinks that it needs to ape the Federal Reserve and sacrifice economic growth to lower inflation. However, it still hasn’t specified how higher borrowing costs will accomplish the latter.

First among officials’ justifications is that, unlike in the U.S., core inflation that excludes commodity prices hasn’t stabilized. “Energy is still, of course, the main source of inflation,” Ms. Lagarde said, “But we also have an inflation that spreads across a larger range of sectors.” Yet she herself added that raw-material inflation is likely behind this too, as higher input costs eventually lead most businesses to raise prices. Europe’s dependence on Russian gas makes these impacts higher than in the U.S., as does the euro’s depreciation.

The ECB president also conceded that “incoming data and recent wage agreements indicate that wage pressures remain contained,” dispelling fears of a cost spiral. Despite alarmist talk about some German trade-union demands getting more ambitious, negotiated wages in the eurozone rose a paltry 2.1% in the second quarter. With purchasing power plummeting, after accounting for inflation, surveys suggest that consumption will suffer.

As for households’ inflation expectations—often overly emphasized by central banks as causing entrenched inflation—Ms. Lagarde referred to the ECB’s own polls, which show little increase when looking three years ahead.

So what is left? In a speech at the Jackson Hole central-bank symposium a couple of weeks ago, Isabel Schnabel—a traditionally cautious, data-driven member of the ECB board—dug into surveys to point out that “people who are financially literate” and have a less backward-looking view of the economy have upgraded their inflation expectations by more, and claimed that “determined action is needed to break these perceptions.” Why the expectations of the better-informed should matter more is unclear. 

Rate setters have shown they only care about one thing: Whether the headline consumer-price index number is above the 2% target they are mandated to hit. It doesn’t matter whether or not they have the tools to hit it. As pointed out by Philippa Sigl-Glöckner, director of German think tank Dezernat Zukunft, their hawkishness is reinforced every time their CPI forecasts prove to be too low, but “that’s circular logic.”

Over the long term, the economic outlook will likely force the ECB to stop. German government-bond yields seem to suggest that rates will average 1.6% over the next 10 years, which seems broadly appropriate given the eurozone’s endemic weaknesses.

At present, though, with high inflation despite no signs of an overheating economy, the ECB’s justifications for its actions have become thin. On Thursday, Ms. Lagarde said she didn’t know what the end level of rates should be. And she once again left undefined the criteria under which the ECB’s latest bond-buying tool, announced in July, will be activated to help weaker Southern European nations: “I don’t have much more to say,” she said.

This may become the ECB’s motto for the 2020s.

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