Things are rattling the cage again in the eurozone. But, there is a risk that the situation will become even more difficult to manage than the last euro crisis. Haw will the European Central Bank (ECB) deal with the challenge of combatting inflation and at the same time ensure European cohesion.
The ECB faces a challenge that could be even on a higher scale faced more than a decade ago when the euro crisis erupted. It is simply the continuation of financial crisis, which remained essentially unresolved. With other words, the ordinary people will have to pay the price for printing irresponsible amounts of money and kicking the can down the road by implementing a low interest rate policy for too long .
While the ECB’s decision at the time to buy government bonds to an unprecedented extent was able to alleviate the massive interest rate pressure on the highly indebted members of the eurozone. But now, rising energy prices, inflation and a government crisis in Italy are causing the so-called “spread” (the difference between the level of interest rates of German government bonds and so-called “peripheral” sovereign debt, such as those of Italy or Greece, to rise sharply again. We have seen temporarily the highest level since 2013 in the course of this year.
There are 3 major factors that lead to a significantly different situation and do not allow a simple copy of the measures that prevented the eurozone from falling apart 10 years ago:
1. The highest inflation rate since the introduction of the euro.
2. The war in Ukraine that is fuelling inflation and stoking fears in global financial and capital markets.
3. A even much higher level of public debt in the euro area as a whole than 10 years ago.
The ECB claims publicly to fulfil its mandate to ensure price stability and is slowly but steadily raising the key interest rate, most recently by as much as 0.50 percent. At the same time, the ECB has made it clear to continue to support the cohesion of the eurozone.
But these 2 objectives contradict each other. Stopping the purchase of government bonds and raising interest rates in order to get inflation under control, while pledging that the prices of the bonds of crisis-stricken euro countries will be capped, corresponds to trying to “square the circle”.
What will happen when the financial markets will put these contradictory ECB targets to a stress test?
Global financial markets are neither patient nor far-sighted, so a timely escalation of the ECB’s dilemma of simultaneously containing inflation and keeping the cost of financing certain sovereign debt low is to be expected.
So, if it comes to a state of emergency, the big question is what priorities will the ECB set? Trying to keep inflation under control and stop the devaluation of people’s money or keeping the cost of financing certain sovereign debt low?
Time will tell and the financial markets will react accordingly.
Sven Franssen