ECB Policy Brief: You can call this stagflation

The ECB’s decision today confirms last week’s policy brief (see below):

It raised the key interest rates to underline its determination to fight inflation and has given clear guidance on how it intends to act in the time ahead.

The statement reads: “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target. The Governing Council’s future decisions will ensure that the key ECB interest rates will be set at sufficiently restrictive levels for as long as necessary. The Council will continue to follow a data-dependent approach to determining the appropriate level and duration of restriction. In particular, the ECB Governing Council’s interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.”

This indicates the target rate has been reached, provided future data confirm today’s underlying projection. So the ECB Council is not ruling out future increases in principle, but signalling its willingness to raise interest rates even further if necessary. President Lagarde stresses that the guidance does not mean the target rate has been reached. But the hurdle for further rate hikes is likely to be quite high after today’s decision was already not unanimous. In principle, the ECB Council has not ruled out rate cuts either. However, the emphasis on the long duration suggests that the Council might consider rate cuts in the coming months only given a surprisingly rapid fall in the inflation rate.

Thus, we stick to last week’s assessment: “There is little to suggest that the European economies will slide into a severe recession. Only then would the central bank be forced to ease interest rates again soon. Much more likely is a scenario in which the economy weakens but doesn’t crash. In this scenario, labour will remain scarce because the retirement of the baby boomers is proceeding apace. In Germany this will affect the 1958 cohort next year, reaching the statutory retirement age of 66. Other factors also point to continued price pressures even in a stagnation scenario: geopolitical bloc formation, trade fragmentation, commodity scarcity, decarbonisation costs and disrupted energy markets. In 2024, the ECB could thus be confronted with a situation in which the inflation rate falls only very slowly. But the Council would probably try to avoid further interest rate hikes – though it might keep the option of steps upwards as well as down open in its communication.“

Regarding the Public Puchase Programme, the Council has confirmed its guidance, but we would expect that this issue could come up again next year. The roll-off could well start earlier, provided spreads between sovereigns do not widen significantly.


Read the BGA Euro Policy Brief


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