“Inflation effectively requires monetary authorities to navigate by sight”

VSFaced with inflation reaching a record level in the euro zone (9.1% in August), the European Central Bank (ECB) finally decided to raise its key rates by 0.50% at the end of July, while confirming the implementation a new tool likely to weigh on sovereign rates in the euro zone: the Transmission Protection Instrument (TPI). The ECB has also abandoned its so-called “unconventional” measures, such as asset purchase programs “quantitative easing”. This “normalization” phase follows a decade characterized by a particularly accommodating monetary policy.

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But this monetary tightening comes at a time when an economic slowdown is looming, which could lead to a situation where the States of the euro zone, and the economic system as a whole, risk finding themselves once again dependent on the support of the ECB.

The monetary authorities are therefore not only facing an inflationary shock, but must also factor in the risk of a financial crisis in their decisions. Thus, the euro zone is once again confronted with a risk of fragmentation, which is already manifested by a deterioration in the financing conditions of the most fragile States, in particular Italy.

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This is why the ECB has resolved to set up a new tool, the TPI, intended to stem the tensions on sovereign rates that have appeared recently, while preserving its ability to intervene. While the conditions for activating the TPI remain deliberately vague at this stage (probably to maximize its scope and effectiveness), the introduction of this new tool shows that the ECB is not in a position to completely withdraw its support to the economy. But unlike the 2010s, when inflation remained sluggish, the monetary authority has little room for maneuver and thus finds itself in the grip of a dilemma.

Desynchronization Europe – United States

By declaring that it wants to fight against excessive inflation and the risk of fragmentation at the same time, the ECB finds itself confronted with objectives which presuppose contradictory means of action. The first implies a tightening of financial conditions, while the second supposes on the contrary their easing (which should certainly be “targeted”, but the contradiction remains).

This paradox opens an era of political uncertainty, because it forces the monetary authorities to navigate by sight. Consequently, the President of the ECB, Christine Lagarde, announced the suspension of the use of the forward guidance (formally in force since 2013), which consists of warning economic agents of the intentions and future actions of the central bank.

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