Higher still. The European Central Bank (ECB) raised the price of money again yesterday for the eighth time in a row (counting from the beginning of the bullish cycle, just over a year ago).
The interest rate on the main financing operations is already 4%: it is the highest level in the last 22 years. And attention: the increases are not over yet! As its president, Christine Lagarde, admitted in the subsequent press conference, during yesterday’s meeting “there was no talk of a pause in the hikes at any time” nor “the time has come to think about it ” (and, moreover, it seems, according to her, that there was a broad consensus on this point).
Therefore, the European issuing institute is following in the footsteps of the Federal Reserve (Fed), which on Wednesday left rates unchanged after 15 months.
It is true that the ECB is four months behind, compared to the US, when it comes to addressing the change in the cycle. But Lagarde took it for granted that there will be another increase in July. Although in the press release there is no official mention of future steps, the French woman said again that “there is still a way to go”. “Is the journey over? No. We have not reached our destination”, said the president. “I can go further: unless there is a material change that affects our base, it is likely to be the case that we continue to raise rates in July, which will not surprise them,” he responded to a reporter’s question .
What is the reason for this hardness of the European Central Bank, despite the fact that the eurozone has technically entered recession in the first quarter and inflation is already far from the peaks reached during the war in Ukraine?
The decisive factor has been the ECB’s upward revision of core inflation data (that is, that which excludes the most volatile items such as energy and food), which will remain high due to, mainly from the strength of the labor market and the strong increase in wages and unit labor costs.
In a word, Lagarde is worried about the rise in wages, although she pointed out that we are not facing a spiral or the dreaded second-round effects. Yet. The data confirm that the unemployment rate in the Eurozone is at historic lows (6.5%) and – attention – the forecasts indicate that unemployment in the Eurozone could drop further (to 6.3%) ). And that the economy is in recession! “It’s an enigma”, acknowledged Lagarde.
This description of a dynamic labor market should, in theory (and not only), be good news. But the paradox is that, from the point of view of monetary policy, it is not so much.
Because if the economy is stagnant (mild recession) and jobs continue to be created (one million jobs in the eurozone in the first quarter), wages necessarily go up. “Wages are expected to grow at much higher rates than the historical average, both in the public and private sectors, and to reflect compensation for inflation and the rigidity of the labor market: 5.3% in 2023, 4, 5% in 2024 and 3.9% in 2025”, says the ECB. And “salary pressures, even if they are one-time payments, are becoming an increasingly important source of inflation”, declared Lagarde. “In addition, some sectors have been able to maintain relatively high profits”, he emphasized.
Frankfurt now believes that core inflation in 2024 will be half a point higher than previously forecast. It predicts that it will reach 5.1% in 2023, before falling to 3% in 2024 and 2.3% in 2025. Percentages that are still too high and “not satisfactory”, considering that the The ECB’s target is 2%.
Raphaël Gallardo, chief economist of Carmignac, asked by this newspaper, introduces the following nuance. “I think that the hawks of the European Central Bank are interested now not so much in interest rates going up more, but in staying high for a prolonged time before going down too soon.”
These analysts explain, paradoxically, that a recession in Western economies is inevitable and, in a way, almost desirable. The thesis is that inflation, which was initially driven by the crisis in the supply of raw materials, the post-pandemic congestion of maritime trade and the rise in energy prices with the Russian war, is now kept alive by two components.
One is precisely the increase in wages, fueled by a mismatch in the labor market, in which there is more employment supply than demand and with a still very low unemployment rate. The other is the high business margins, a reflection of the rise in the prices of goods and services, based on firm cash flows from the companies on their balance sheets. “Economies are showing greater resilience than expected”, they argue in Carmignac. And the fact is that demand continues to be driven also by the excess savings accumulated during the covid confinement. And that puts pressure on prices. And the wages. God forbid!
