The ECB declares war on inflation and anticipates turbulence in the markets of southern Europe

The ECB declares war on inflation and anticipates turbulence in the markets of southern Europe

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The European Central Bank (ECB) has surprised the market this Thursday. There was an expectation of consensus in 0.25 points, as the agency announced in June, and has ended up being double. Analysts agree that this decision is conditioned by the latest inflation data, from the 8.6% in the eurozone. This increase will have a negative impact on economic growth, on the ability of families and companies to borrow, on the family budget of those families that have debts. The goal is to cool demand: reduce household consumption and business investment enough to calm prices spurred on by the energy crisis and supply disruptions.

“The problem with the European Central Bank is that it is always accused of being very conservative, that it is wrong, that it is always late, and that when it acts, it falls short,” explains Antoni Garrido, professor of Applied Economics at the University of Barcelona. The scholar believes that the will to regain some lost credibility is behind this surprise announcement. “As the market already discounts my credibility, I am going to discount that I am willing to do my job well done and my job is to stop inflation above all else”.

The main argument to defend this thesis is that in the 24 years of history of the European Central Bank has ended up assuming more functions, in addition to controlling price stability. “All the European Central Bank is doing is covering up the design problems of the Eurozone Banking Union. The problem is that it serves many fronts. We are asking him to take care of inflation, of risk premiums, that the banks have financing… However, sometimes he cannot, because sometimes the objectives are contradictory”, explains the professor. So a blow on the table: containing inflation is the priority.

To avoid the breakup of the euro zone

The two levers to control economic cycles are monetary policy (interest rates, a tool transferred to the European Central Bank) and fiscal policy (taxes, the responsibility of each country in the euro zone). Professor Antoni Garrido believes that the fact that the European Central Bank does not control both will always mean that it will not have a sufficient arsenal to control what happens in the euro territory. And transferring fiscal sovereignty is not something that is planned in the short term: “If there have been times between some Catalans to finance a road in Extremadura, since there are some who consider it something against nature, I am not telling you between the Dutch and Greeks”.

To prevent the seams from jumping between the north and south of the eurozone, and to ensure that monetary policy is transmitted to all countries, this Thursday Christine Lagarde has presented the anti-fragmentation mechanism. The purpose is to prevent the rise in rates from putting the economic accounts of the most indebted countries on the ropes, which, like households and companies, will also find it more difficult to find financing. This is what causes the risk premium of these countries to skyrocket. “This mechanism is the way to compensate for the original sin of the eurozone,” says Antoni Garrido.

The mechanism is simple: the European Central Bank will continue to buy debt from those countries that need it. “It will work. This is a strong measure.. It will buy unlimited debt from countries that need it, with flexibility. What the ECB is doing is plugging the wound”, says Garrido. The monetary body imposes four requirements: not to suffer an excessive public deficit, the absence of severe macroeconomic imbalances, maintain a path of sustainable public debt and solid macroeconomic policies, in accordance with the objectives of the Recovery Plan.

the financial analyst Xavier Santacruz agrees that the measure is correct: “I think it is a new instrument. You try to buy more from the countries that need it most. I wouldn’t be surprised if it works reasonably well, although it is true that not much detail has been given about how it will work on a day-to-day basis”.

The main candidate countries to benefit from this cushioning system are the most indebted, such as Italy. The departure of Mario Draghi from the Italian Government and the call for early elections are causing concern within the European Central Bank. A governance crisis in the transalpine country and a lack of discipline over its public accounts would put the possibility of resorting to the anti-fragmentation mechanism against the ropes.

Objective: stop the bleeding of the euro

On July 22, 2021, a year ago this Friday, we could buy 1.18 dollars with one euro. Today with that same euro we can buy only 1.02 dollars. That figure of 16 cents (-13%) may seem little to a consumer, but if we talk about the millionaire figures, the impact becomes more than evident. For the same price, the euro zone today buys 13% less oil than a year ago. Energy is the engine of any economic activity, so an increase in the price of this raw material affects practically any good or service that comes to mind.

This rise in interest rates has an immediate effect”, Javier Santacruz points out. “As soon as the euro begins to recover against the dollar, it will automatically generate a drop in the cost of imports. It is absolutely essential to reduce inflation”, explains the analyst.

Impact on the economy

The president of the European Central Bank, Christine Lagarde has admitted that the effects of the war in Ukraine they are assuming a “ballast” for the euro zone economy. The rise in interest rates is a contractionary measure for the economy, so it is negative both for economic growth, and for households and companies that need financing or for those that are already in debt, with a fee linked to the euribor.

Short term, the most benefited are the banking entities. “The banking business is a margin business. Raising interest rates improves the price of credits already established. Although in the long term they will have to remunerate deposits again, so their expenses will also increase, the balance will continue to be positive”, explains analyst Javier Santacruz.

The analyst believes that a scenario in December with a 2% Euribor is feasible, something that would make variable-rate mortgages much more expensive. “It is likely to go up considerably. This, like all decisions, there are always winners and losers. One of the losers are the mortgaged. But the number of losers is much lower than it was years ago.” Santacruz is referring to the exorbitant mortgages issued during the financial crisis.

This is how four million mortgages will rise from August due to the ECB’s decision

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