The era of zero and negative interest rates is over unless you live in Switzerland, where rates are still -0.25% even after a 0.5% hike. Curbing soaring inflation is now the biggest immediate challenge facing central banks. This is especially bad news if you have a mortgage. another extra cost to put alongside your growing heating bills, while savers will only get a few extra pennies on their bank savings.
The painful truth is that the cost of living crisis is now starting to hit European wallets, and there is little governments or central bankers can do to help.
While central banks in Washington, London and Zurich raised their base rates this week, the European Central Bank stayed put, but that won’t last long. The ECB promised to end its bond-buying program next month and indicated last week that it would raise the base rate in July by 0.25% and then again in September.
Paul Krugman believes core inflation is closer to 4%, with almost all of the excess caused by Russia sanctions, and the Federal Reserve and other central banks could overreact .
However, it seems that the ECB has little choice. The massive quantitative easing program launched when Mario Draghi promised to do “whatever it takes” in 2012, which has continued since, supplemented by an additional program following the COVID pandemic, was much easier to sell when inflation and interest rates were close to zero.
Nearly 8% on average, although rates vary and are higher in the Netherlands, for example, inflation in the Eurozone is lower than in the United Kingdom and the United States, but not that much . The risk is that more money printing would lead to an inflationary spiral reminiscent of the price spikes caused by the OPEC crisis in the 1970s, when inflation hit 15%.
What can be done to limit consumer pain and avoid falling back into another recession?
For countries that can, price caps or subsidized utility bills and petrol prices are urgently needed to ease some of the consumer pain and keep millions of Europeans out of poverty . Rising spending on food, energy and now housing bills will limit consumer spending elsewhere, as people cannot afford luxuries.
The problem for monetary union is twofold. These subsidies will inevitably lead to more deficit-oriented spending. Tax hikes – even those that explicitly target energy companies – tend to stunt economic growth, which, in turn, translates into lower incomes. But the public debt burden in the EU is much higher than before the pandemic. The eurozone average stood at 95.6% of GDP at the end of 2021 compared to 83% two years earlier, significantly higher, by the way, than at the height of the eurozone debt crisis. .
The value of the EU Recovery and Resilience Fund, the €750 billion program of grants and loans borrowed from the EU budget, is now highlighted in technicolor. But the arrival in national treasuries of the first tranches of billions of euros from the RRF will only partially cover the new costs facing governments.
The other part of this Gordian knot is that in the apparent absence of an ECB bond-buying program, the bond market will put pressure on Italy, Greece and other highly indebted countries. of the euro area. Recent weeks have seen a widening of spreads between German and Italian bonds, although they are not yet close to a crisis point.
The ECB’s determination to do “whatever it takes” may well be tested in the months ahead. In the meantime, the bank will have to hope that a deflated balloon can weather the coming storm without crashing to earth.