Lagarde: watching over the debt of the south is a necessary condition to lower inflation

The president of the European Central Bank (BC), Christine Lagarde, emphasized yesterday that avoiding the fragmentation of the eurozone –preventing the distance between the interests paid by the different countries of the eurozone from being so wide that it blocks the effects of monetary policy– "It's a precondition for bringing inflation back to our target" of 2%.

Thomas Osborne
Thomas Osborne
29 June 2022 Wednesday 01:00
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Lagarde: watching over the debt of the south is a necessary condition to lower inflation

The president of the European Central Bank (BC), Christine Lagarde, emphasized yesterday that avoiding the fragmentation of the eurozone –preventing the distance between the interests paid by the different countries of the eurozone from being so wide that it blocks the effects of monetary policy– "It's a precondition for bringing inflation back to our target" of 2%. Put more clearly, the ECB warns that if the markets punish excessively the debt of the countries of southern Europe, mainly, but not only, Italy and Spain, it will intervene to reduce these differences with respect to the reference countries of the eurozone. Germany first.

The markets have already pushed up interest rates on debt across the eurozone by some 2.40 points on 10-year bonds, without even a single official rate hike having yet been executed. It is called anticipation.

The ECB will launch its monetary policy turn next Friday, accompanying it with the reinvestment of the debt in its possession that reaches its maturity in debt purchases from the countries that may be most affected by this market pressure. That is the first flexible line of defense in the fight against inflation.

What would be the limit of this disparity from which the ECB would have to intervene? Nothing is clear about that yet and several technical groups are discussing the matter. Yesterday, Lagarde made a generic approximation: when the interests in some countries respond in a "rapid and disorderly" way "above what would be justified by their economic fundamentals."

And the debate, of course, is not only technical, it has a high content of discussion about politics and economics. Above all, the one that derives from the conditions that would be rigged for the action of the governments affected by these purchases. The hardliners, grouped around Germany, would like stronger demands, they are the hawks. The others, a lighter conditionality. The sources consulted by this newspaper think that the final agreement will not bet on harsh demands and will be applied in coordination with the European Commission, which has already imposed some linked to the receipt of European recovery funds and would include the presentation of a sustainability program of public finances in the medium term.

But yesterday Lagarde's goal was to make it clear that although there may be differences within the council, the determination to intervene to avoid fragmentation and threats to the euro is not in doubt.

This divergence in the cost of national debts has already occurred this month, when that of the Italian debt skyrocketed, above all, somewhat less, although also, the Spanish debt, which forced the ECB president to call an extraordinary meeting of the tip. After her, she announced the reinvestment in debt securities of countries that are potential targets of market attacks. Lagarde once again made it clear that the new monetary policy will be applied gradually, paying attention to its consequences.

To put pressure on national governments, he reminded them that their fiscal policies to fight inflation must be directed at the most affected sectors and must be temporary, while keeping the increase in their debts under control.

Lagarde emphasized that attitude of the ECB while defending its determination to combat inflation in the eurozone: "We will go as far as necessary to ensure that inflation stabilizes at our 2% target." He although he admitted that real wages in the eurozone had lost purchasing power in the last two quarters, but the bank's forecasts point to increases of 4% this year and the next.

He said it in Sintra, the aristocratic and beautiful Portuguese town where the bank celebrates its annual Forum. A meeting of central bankers, this time immersed in the mist of the omnipresent uncertainty that projects a new economic era, with unexpected price increases, the subversion of energy supplies and a war on the very borders of Europe.

For the ECB, both objectives, protecting indebted countries and combating inflation, are compatible and can be undertaken with independent tools.

Lagarde recalled that the bank's board has already announced an immediate rise of 25 points at its next meeting on July 21, that "we hope to rise again in September" and if inflation persists, at that meeting "a higher rise will be appropriate" . This is also another element of debate, since the toughest members of the central bank council see the need for initial increases of 0.5 points, arguing that the ECB's reference rate is still negative, -0.5%

The president of the ECB recognized the challenge of undertaking interest rate hikes to tackle inflation when the economy is already showing signs of slowing down; in fact, the bank has revised downwards its growth forecasts for the eurozone for the next two years. Not only that, some basic variables of the activity are still below the records prior to the pandemic, as is the case of private consumption, 2% less, or investment, which has remained flat. But that is now the central scenario of analysis, high and persistent inflation, which will force interest rates to be raised, with an economy in rapid decline. A pressure cooker that predicts clashes between governments and central bankers.