Europe’s economic problems are threatening to crush the ECB

Europe is standing on a shaky ground, and I can see the European Central Bank (ECB) is holding a hammer, but I’m not sure if it’s to fix or further crack the foundation.

So central banks had their eyes popped wide open by an unexpected energy showdown led by Vladimir Putin, among other pressures that pushed inflation through the roof. Suddenly, those in charge of the money had to learn how to ride a wild bull. And just when I thought the ride couldn’t get any crazier, the Swiss National Bank decides to surprise everyone with a rate cut, hinting that maybe… just maybe… the peak of interest rate hikes in the continent’s advanced economies is behind us.

The ECB is now in the spotlight, and word on the street is that a rate cut is on the horizon, likely hitting us in June. Christine Lagarde hinted at this in her speech, pointing out that they’re eyeing wage growth, unit profits, and productivity like hawks to see if disinflation is actually happening.

But hang on, there’s more to this than just the immediate future.

The past three years have been a roller coaster for the ECB, with inflation turning their forecasts into what might as well have been scribbles. Philip Lane, the ECB’s chief economist, told us that their predictions fell short mainly because of energy and food prices acting like they’re on a bungee jump. But hey, guessing the market’s next move, especially with Putin in the picture, has got to be nearly impossible. So I’m not even judging.

But then the ECB did some number-crunching and found out that, just like in the U.S., Europe’s inflation drama was mostly about supply issues. This whole situation made the guys at ECB question if there was anything they could’ve done differently.

And spoiler alert? Probably not.

The Deep Freeze of Monetary Policy Strategy

It looks like the ECB’s shiny new monetary policy strategy, revealed with much fanfare in 2021, hit a snag when inflation started to smirk at them from across the room. It’s like the confidence in their own forecasts took a nosedive as inflation hit a 40-year high, leaving them to rethink their strategy of being chill with current price hikes as long as the future looked kinda sorta bright.

But instead, the ECB went into what Isabel Schnabel called “robust control” mode, basically tightening the reins because, let’s face it, their forecasts weren’t giving them much to go on. Now, there’s some rumor going on about a “last mile” challenge in getting inflation to cool down to their 2% sweet spot. The ECB’s predictions expect inflation to hit 2.2% by mid-year. Impossible.

Lagarde made it clear that even after they start cutting rates, they’re not locking themselves into any specific method. She was basically saying, “Yeah we’ll cut rates once, but don’t hold your breath for what comes next.”

Not exactly a confidence booster, huh Christie?

Profits, Wages, and the Way Forward

The ECB is now paying more attention to profits than they used to. Lagarde and her team have been dropping hints that maybe we shouldn’t just obsess over wages when talking about inflation. Piero Cipollone, another one of ECB’s economist, even gave a whole speech about how understanding profit trends can give us a clearer understanding of inflation’s root causes. This is a breath of fresh air considering how Europe previously had its sights set too narrowly on labor costs, missing out on the bigger picture.

But don’t expect a crystal-clear framework from the ECB just yet.

Seems they’re still trying to figure things out, especially if disinflation picks up pace. There’s a camp within the ECB that’s itching to loosen up sooner to avoid falling back into old habits of unconventional policies.

And let’s not forget the voices cautioning that the full impact of the ECB’s tightening might still be ahead of us. Both the Bank of Spain’s governor and Axel Weber of Bundesbank, are saying Europe might not be out of the woods yet.

As for Schnabel, she’s diving into the tricky business of figuring out the neutral interest rate that doesn’t mess with economic activity too much.

So here we are, surrounded by uncertainty, waiting for the ECB to shed more light on how it plans to get through all of these problems.

The sooner it clears the fog, the better for everyone trying to make sense of Europe’s economic conundrum.