How is the ECB reacting to higher inflation?

The ECB Council will not meet for an interest rate meeting for four weeks. But it is already becoming apparent that there will be heated discussions. Some council members want to at least slow down the pace of bond purchases.

The rise in inflation should challenge ECB President Christine Lagarde.

Dhe surprisingly higher inflation in America and the somewhat higher inflation rates in this country are of particular concern to investors and consumers. How will the European Central Bank (ECB) react to this? In around four weeks, on June 10, the Governing Council will meet for the next interest rate meeting. And it can already be seen that it will not be an unimportant meeting, say economists and analysts. “A heated debate can be expected at the meeting on June 10,” writes Michael Schubert, ECB expert at Commerzbank. The ECB had recently increased the pace of its bond purchases to counter a premature rise in bond yields. It does not have to stay that way.

In contrast to the United States, there is still no speculation in the eurozone about the possibility or timing of an increase in key interest rates. The ECB has made it clear that it will continue to buy bonds to combat the crisis for a long time to come and will definitely not raise interest rates before the program ends. But the significantly higher American inflation and the slightly higher monthly inflation rates in this country should not leave the ECB Council completely unimpressed. At the meeting on June 10th, the central bank will decide on the pace of its bond purchases in the next quarter, that much is already known about the agenda.

The ECB could reduce the pace of bond purchases

In the Governing Council, the pace for the billion dollar bond purchases is controversial. The Dutch central bank governor Klaas Knot had even brought it up to begin with the exit from the PEPP crisis program in the third quarter. Other members of the Governing Council, especially the southern European countries particularly hard hit by the crisis, such as Italy, want to keep going. ECB observer Schubert expects that the central bank will slow down the pace of its bond purchases a little in the end, but that it will still be above the pace at the beginning of the year.

ECB President Christin Lagarde has announced that she wants to “look through” the higher monthly inflation rates. The ECB is pursuing an inflation target of “below, but close to, two percent” – albeit in the medium term, and on average for the entire euro zone, not for individual countries. The inflation rates for the euro zone were again significantly higher in the first four months of this year than in the last four months of last year. But 2 percent has not even been achieved on a monthly basis.

However, that could change in the course of the year. In April, inflation in the euro zone was 1.6 percent, and the ECB itself is also expecting a further increase. Another boost is to be expected in May because energy prices were very low in the month last year. In July there is another technical increase, because the value added tax in Germany was reduced in the previous year. Then prices with the higher VAT from this year are compared with those with the lower one from the previous year. That drives the inflation rate. In addition, rising commodity prices and easing steps are likely to have an impact on the economy as well as temporary bottlenecks on the supply side.

Very different inflation rates in Europe

In March, the ECB had already raised its forecast for the inflation rate for the year as a whole, from 1 to 1.5 percent. But that shouldn’t be enough. One problem with this: Depending on the euro area, inflation varies greatly, depending on the initial situation and how the pandemic is managed. In Germany, the inflation rate was already 2 percent in April, and prices for heating oil and gasoline rose by more than 20 percent. ECB Executive Board member Isabel Schnabel and Bundesbank President Jens Weidmann even expect inflation of more than 3 percent for individual months in Germany this year. However, after all that can be foreseen so far, it is unlikely to be that much for the euro zone as a whole. But the surprising 4.2 percent in America in April also teaches us once again that inflation rates are difficult to forecast.