ECB. Lagarde shoots inflation and wakes up the “ghost” of the debt of countries like Italy and Portugal – Observer

“We never make any prior commitments”. Gone are the days when the ECB, in the words of former President Jean-Claude Trichet (2003-2011), never agreed to a decision that it could (or could not) make in a few weeks or months. Continuing the style change brought about by Mario Draghi, the ECB, led by Christine Lagarde announced this Wednesday that does not change interest rates at the moment, but will raise them next month and again in September – and at the same time it can even be double: it is enough for inflation to continue without showing signs of improvement. However, by shooting inflation, Lagarde couldn’t help but wake up another “ghost”: The “ghost” interest on public debt in the countries of Southern Europe.

By the end of September, interest rates will not only come out of the negative “territory”, but may even become above zero. This has become the central monetary policy scenario, according to what the European Central Bank (ECB) said this Thursday. AS WELL AS this is new: whereas before this Governing Council meeting, analysts were divided on whether the ECB would raise interest rates by 25 bps in July and another 25 bps in September, or alternatively by 50 bps all at once in July, the scenario has now been changed to 25 bps basis points in July and another 50 points (half a percentage point) in September.

This does not even require worsening inflation forecasts. (cumulative) increase of 75 basis points over three months confirmed – it is enough that they do not improve, the ECB pointed out. And no one knows if they will improve, but the interest rate futures markets quickly began to gain not only those 75 points before September, but much more over the last three months of the year. In other words, with interest rates holding negative -0.5% this Thursday, the expectation became The eurozone will end 2022 with base rates around 1%, with a trend towards further growth next year..

From Amsterdam (and not from Frankfurt, as usual), Christine Lagarde signaled that the interest rate hike, now announced in advance, “it’s not a step, it’s part of the journey“to fight inflation that will continue”undesirably high” and which is expected to end the year with an average (annual) value close to 7%, more than three times the target set in the central bank’s mandate. Even after September, the trend will continue with a “gradual and steady” increase in interest rates.finally leaving behind the long period of low (and even negative) interest rates that has characterized the last decade.

But interest rates are not rising just because there is inflation and the need to “normalize” monetary policy after so many years of very low interest rates: the ECB has also tried to get the message across that the economy needs higher interest rates. has good prerequisites for growth in the “medium term” – and only the war in Ukraine hinders this process.

This note of optimism does not seem to be in line with the “major revision” made by the ECB regarding growth forecasts for the euro area: growth forecast for 2022 decreased from 3.7% to 2.8% and in 2023 – from 2.8% to 2.1%. However, this ‘Lost’ growth to partially recover in 2024estimates the ECB, which has improved its growth forecast for this year from 1.6% to 2.1%.

“Russia’s unjustified aggression against Ukraine continues to hurt the economy in Europe and beyond,” the ECB said, adding that because it “disrupted international trade, [a guerra]leading to material shortages and pushing up the price of energy and raw materials.” However, in this note of optimism, the ECB says that conditions for further growth of the economy, taking advantage of the economic recovery, a strong labor market, fiscal support and savings accumulated during the pandemic.”.

In terms of inflation, economists have begun forecasting a 6.8% rise in prices in the euro area in 2022 and then a decline in the annual inflation rate to 3.5% in 2023. In 2024 alone, the ECB’s medium-term target of 2.1% (target of 2%) is expected to be closer to inflation. “Moderating energy prices, improving global supply chains and normalizing monetary policy are factors that are expected to lead to lower inflation,” the ECB said in a statement.

“High inflation is a huge test for all of usis indeed the first sentence of the ECB communiqué. “The Board of Governors will ensure that inflation returns to the 2% target in the medium term,” he assured then.

Rapid price growth, however difficult, is not the only enemy the ECB will have to contend with in the coming months. As Lagarde spoke in Amsterdam this Thursday, interest rates in countries in the south of the eurozone, such as Portugal and Italy, have picked up pace in recent weeks. 10-year interest rates in Portugal jumped 15 basis points to 2.66%.while rates in Italy rose 22 points to 3.69%. Italy debt risk spread against Germany up to 220 basis points (highest since May 2020).

This was due to the fact that the ECB did not provide more specific information on what tools can be used to avoid an overly sharp increase in the financial costs of these countries. And about two hours after the end of the press conference, it became known that “most governors” did not want to announce a specific answer to this problem. It was not Lagarde who said this, but the usual anonymous “sources” at the ECB, who usually speak to the main international financial agencies shortly after the presidential press conference (which often looks like a “settlement of accounts” with an official announcement). announced by the President a few hours earlier).

However, even when deprived of this “majority” to say anything more specific, Lagarde assured that the central bank will not tolerate excessive “fragmentation” of the eurozone. And he only added that the ECB is “watching” this movement and will act.”if it is needed“to ensure that there is no such ‘fragmentation’ of monetary policy, that is, that the policies set in Frankfurt lead to the same results in all jurisdictions. However, this healthy transmission will be threatened if, as happened during the sovereign debt crisis, countries have very different interest rates.

For example, with the difference in risks between Italy and Germany exceeding 200 basis points (two percentage points), there are clear signs that speculation is taking shape in the financial markets that interest rates in so-called periphery countries could rise to problematic levels. levels. “Fragmented financial markets will be a drag” on monetary policy, Lagarde said, ensuring that even after it was announced that new debt purchases ended on July 1, there was “flexibility” to apply existing instruments or develop new ones. “We have already demonstrated in the past that we are capable of doing this, and we will do it if and when the need arises.shot the president of the ECB.

Interest rates on debt in countries such as Italy (blue) and Portugal (green) have accelerated growth in recent months, widening the gap for Germany, whose 10-year interest rates have also risen, but below 1.5%. SOURCE: Trade Economics

The message was vague and clearly read from a cheat sheet. But while Lagarde tried to be assertive in the sense that she ensured that the ECB could intervene again in government debt markets “if necessary,” investors weren’t impressed. “The failure of the ECB to provide more details on its security plans [para este problema crescente] So this country debt risk premiums outskirts will continue to expand”suggested Andrew Kenningham, chief European economist at Capital Economics.

For Portugal, this will mean that future debt will continue to become more and more expensive, while new debt pays less than old debt that has expired in the last few years. This was the soil that gave the grapes: ECB market purchases that end at the end of the month have been achieved by Finance over the past 10 years. halve the average cost of all public debt, to almost 2%. But with rising interest rates in the financial markets, only by resorting to shorter terms can the state finance itself below this average level.