ECB President Christine Lagarde is grappling with an unpleasant mix of risks to the region's economy.

London (CNN Business)The European Central Bank still won’t say when it might start raising interest rates, even as inflation surges to another record high. Given war in Ukraine, as well as a Covid surge in China, it wants to keep its options open.

The ECB reiterated on Thursday that it would only raise the cost of borrowing after it winds down its purchases of government bonds, which it confirmed should happen at some point in the third quarter. Its counterparts in the United States and United Kingdom have both hiked rates in recent weeks as global inflation soared.
“In the current conditions of high uncertainty, we will maintain optionality, gradualism and flexibility in the conduct of monetary policy,” ECB President Christine Lagarde said in a statement that underscored the growing risks to economic growth from the war in Ukraine, pandemic restrictions in Asia, and the associated rise in energy costs that is driving prices higher.

Speaking to reporters from home, where she is recovering from Covid-19, Lagarde said rate rises may not come for weeks or even months after its bond-buying program ends.

“We’ll deal with interest rates when we get there,” she added.

Eurozone inflation hit an eye-watering 7.5% in March, according to figures from Eurostat — its highest level since the European Union started collecting data about a quarter of a century ago. Inflation in Germany, Europe’s biggest economy, hit 7.3%, its highest level in 41 years.
Rocketing energy prices and persistent supply chain disruptions have weighed on European producers and consumers, and the war in Ukraine has only made matters worse, pushing natural gas and oil prices higher as buyers scramble to replace Russian supplies.

The ECB’s position remains largely unchanged from its last meeting in March, held just two weeks after Russia invaded its neighbor. The central bank expects inflation to remain high over the rest of this year before dropping sharply in 2023 and 2024.

Like other central bankers, Lagarde is walking a tightrope: Raise rates too fast, and she risks tipping Europe into a recession just as it begins to recover from the pandemic. Her task is made even more difficult by the fact that Europe is more directly exposed to the economic fallout from the war than the US or UK economies.
Move too slowly, and inflation could remain way beyond the bank’s 2% target. With growth in the eurozone likely to have remained weak in the first quarter, the region is now staring at stagflation — the nightmare combination of high inflation and a stagnant economy.
“History has shown us how easy it is to get this delicate dance wrong,” Sophie Lund-Yates, lead equity analyst at Hargreaves Lansdown, told CNN Business. “The ECB’s decision is in direct contrast to the US, where there have been accusations of potential increases coming too thick and fast.”
Rate rises in Europe are likely to come, but will be “more staggered” than expected, she added.

‘Fantasy’ world?

The ECB’s caution has rattled many in Germany.
Christian Sewing, Deutsche Bank (DB) CEO and president of the Association of German Banks, said last week that a rate hike was “urgently needed” as high inflation was “toxic for the stability” of the German economy.

Otmar Issing, the ECB’s first chief economist and one of the architects of the euro, told the Financial Times earlier this week that his former employer was “living in a fantasy.”
“The ECB has contributed massively to this trap in which it is now caught because we are heading towards the risks of a stagflationary environment,” he told the publication.
While now was not the right moment to hike rates to elevated levels, Issing said that the ECB’s model for predicting inflation was outdated and failed to appreciate the ways the pandemic and the war in Ukraine had caused fundamental shifts in the world economy.

Germany has a deep-rooted fear of inflation, given the role hyperinflation in the 1920s is widely thought to have played in the rise of the Nazi party.
Many Germans are becoming increasingly frustrated by Lagarde’s inaction. Bild, one of the country’s most popular newspapers, has given her the moniker “Madame Inflation.”
Source: Read Full Article