Spreads between Italian and German 10-year debt narrowed on Lagarde’s comments and the free-falling euro reached new 52-week lows versus the US dollar.
In effect at the same press conference as the ECB announced plans to end money printing by the third quarter of 2021 it floated plans to develop a new tool that has capacity for a new asset purchase program.
The plan sounds like a politically-charged fiscal transfer from northern to southern states via the ECB in exchange for it agreeing to lift rates for the benefit of northern states by the end of 2022.
Germany has always been opposed to fiscal transfers, but it now looks like it has little choice to turn a blind eye to another potential bailout program in all but name if it wants rates to rise.
The ECB has previously launched the OMT bond buying program in response to the 2012 debt crisis that ended with sovereign debt forgiveness and the Pandemic Emergency bond buying program in 2020. Now it must hope inflation drops dramatically to the 2.1 per cent it forecasts in 2023 to avoid history repeating.
The latest fracturing and Germany’s aversion to inflation is being accelerated by the pandemic and Ukraine war, but the underlying problems are structural.
Since its launch the euro has made the export and services-based southern economies like Italy, Spain, Greece, and Portugal uncompetitive and resulted in very high unemployment.
Germany and France (to a lesser extent) by contrast have benefited as the euro’s adoption supported their exports’ competitiveness, with Germany posting a decade of huge surpluses including €173.3 billion in 2021.
But a single currency and interest rate for multiple different economies where governments are juggling different employment rates, inflation, and fiscal budgets makes little sense.
Now the chickens are coming home to roost as the ECB ends up politicised by the principle of doing whatever it takes to prevent the eurozone’s break-up.
In Germany, the failure to lift rates has seen French lawyer Lagarde labelled ‘Madame Inflation’ by popular German tabloid Bild, as anti-ECB sentiment builds. While former Deutsche Bank boss Christian Sewing called the ECB’s inaction “poison for the stability of our economy”.
Eurosceptic Germans have previously challenged the legality of the ECB’s bond buying programs in court as a breach of the European Union’s treaty in that they finance governments and any new policy tool specifically targeting this objective is open to another challenge.
This is relevant as fiscal policy is supposed to be the responsibility of national governments and not part of the ECB’s mandate.
Inflation v unemployment
For now, the ECB muddles through between letting inflation run in Germany or letting unemployment remain high in the south and lurches from disaster to crisis in defence of a political project, despite the fact it’s supposed to be a constitutional project.
The long-term solutions are fiscally integrated monetary union (i.e. EU wide taxes and spending) as in the United States in the sense of being a single nation, or an end to the monetary union experiment and return to sovereign currencies.
Amid the mess, far-right and far-left political parties rise in Europe. In France, the anti-EU, anti-NATO, National Rally party of Marine Le Pen has a chance of winning government as it tries to bury reports it’s been funded by Russian bank loans.
Germany – hogtied to a Faustian pact for Russian gas – is scared by the hyper-inflation that fuelled the collapse of the Weimar Republic and rise of Hitler. Many Germans know hyper-inflation arrives once nobody wants to hold a currency backed by a government investors believe cannot service its debts.
Greece suffered a massive depression in 2012, which arrived after ECB president Jean-Claude Trichet increased the benchmark rate 25 basis points in two consecutive quarters in 2011 to fight inflation and accelerate the first European debt crisis.
Italy and Spain have popular right-wing nationalist parties and now face rate rises. Britain has chosen Brexit. While consumer price inflation reached 11.9 per cent in the Netherlands in March.
Thanks to an inflation-fuelled commodities boom and geographic isolation Australia is a relative paradise, where the idea of a far-right fascist political party challenging for government seems absurd.
Notably though, it’s the only developed economy where bond markets called garbage on central bank policy. In November markets forced the Reserve Bank of Australia to abandon its attempts at YCC to keep 3-year government debt at 0.1 per cent. If the bond markets revolt in Europe, all bets are off.