ECB under pressure to act as Eurozone inflation reaches record highs

Inflation within the Eurozone peaked at an all-time high of 7.5% compared with prices in March 2021, placing the European Central Bank under pressure to rein-in its loose monetary policy faster than it originally aimed.

This unprecedented figure was higher than both the earlier record of 5.9% set in February and the 6.6% estimate for March by a group of economists polled by Reuters.

Prices were already rising due to pressures caused by the Covid pandemic (e.g supply side bottlenecks) but it is widely agreed that the war in Ukraine is the single most important factor in this current bout of rapid inflation, with high and rising commodity, fuel and energy costs.

These price shocks come as the Russian President Vladimir Putin threatened on Thursday that he would halt natural-gas supplies to countries refusing to pay for them in rubles. Such an act would only compound supply-side constraints, forcing prices further upwards.

Four countries within the Eurozone reported double-digit inflation, with Lithuania reporting the highest figure of 15.6%. Malta recorded the slowest rate of 4.6% - but this figure is over the 2% figure targeted by the ECB.

Inflation erodes living standards as households are less willing and able to purchase both necessities and wants as their incomes no longer stretch as far, and it is likely that millions in the Eurozone will be pushed into relative poverty.

Falling living standards have prompted policymakers to call for the ECB to reverse its expansionary fiscal policy, which would include bringing forward plans to end asset purchases and raising interest rates for the first time in over a decade. ‘’The inflation data speak for themselves," Joachim Nagel, president of the German Bundesbank, said on Friday. "Monetary policy should not pass up the opportunity for timely countermeasures."

It is hoped that curtailing loose policy will dampen demand-pull inflation; ending quantitative easing should cause interest rates across the economy to rise which is likely to cause household and firm expenditure to fall as the return on savings is high.

Investors have priced in a 0.63 percentage point rate rise by the ECB by the end of 2022 which would bring the main deposit rate into positive territory (from its current low of -0.5%).

However, there is a risk that placing a dampener on demand will do little to alleviate inflationary pressure and will only act to expedite an impending recession by curbing demand-led growth. This risk means that the central bank is being pulled in two directions.

Spyros Andreopoulos (senior European economist at BNP Paribas and former ECB staff member) stated that ‘’The intention was to exit the emergency policy stance and get out of negative rates this year - and my sense is most people at the ECB would have been on board with that. But now they worry the war could have a big impact on growth in the near term, which would delay lift-off to December.’’

The Eurozone (and most of the rest of the world) is experiencing significant downside risks due to war and inflation and many economists are of the belief that market expectations are overdone. Their argument is that high energy prices are impervious to changes in monetary policy and are likely to be a temporary phenomenon whilst weaker growth overall will reduce domestic price pressures, meaning that monetary intervention is redundant.

So far, the ECB has only announced plans to halt net bond purchases by September. It is likely they will continue to observe patterns in price changes before determining if inflation is strong enough to make a rate rise justifiable.


Written by Naomi Adeoti

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