Rising Prices Draghi’s Growing Dilemma

The ECB faces a serious messaging problem. Inflation in the euro zone has reached its target, but the central bank believes it’s only temporary and doesn’t want to ease back on the throttle. Concerns from Germany will only grow louder.
FILE PHOTO: European Central Bank (ECB) President Mario Draghi addresses the European Parliament's Economic and Monetary Affairs Committee in Brussels, Belgium, November 28, 2016. REUTERS/Yves Herman/File Photo

For anyone who thought Germany’s sharp rise in consumer prices in January was a fluke, figures released for the entire euro zone this week will have come as a surprise.

Inflation across the 19-nation currency bloc climbed 1.8 percent in January compared to the same month a year earlier. The figures, released by European authorities Tuesday, came one day after news that prices in Germany, Europe’s largest economy, surged 1.9 percent on the month.

The jump caught analysts somewhat by surprise – prices in the euro zone were seen rising 1.6 percent at the most – and places annual inflation at its highest level in nearly four years.

In theory, Mario Draghi should be pleased. After more than five years at the helm, the head of the European Central Bank can now say he has reached his target.

The Frankfurt-based ECB, which sets interest rates for the entire 19-nation euro zone, has a declared goal of keeping the annual rise in consumer prices in the euro zone “close to but below” 2 percent. That’s the level generally considered healthy for an economy, and it’s the level that the currency bloc has now surprisingly reached well ahead of schedule.

In practice, Mr. Draghi may not be so thrilled. The ECB and many economists believe that rising prices, driven by volatile things like energy and food, are not going to last. Plus the improvement masks a series of underlying problems still bugging the euro zone – problems that Mr. Draghi believes require the central bank to continue with a bond-buying program that has pumped more than €1 trillion into the euro-zone economy over the past two years.

That creates a serious dilemma for the ECB. With inflation near 2 percent, the ECB will have a much tougher job making the case that more easy money is needed. German-led skeptics of Mr. Draghi’s approach are likely to get much louder.

The ECB really should quickly start a discussion about ending the low rates and bond-buying program. Stefan Bielmeier, Chief economist, DZ Bank

Those skeptics include the German central bank, the Bundesbank, which has issued warnings about rising inflation in the past few weeks, urging the ECB to change course and start easing back on the throttle. The central bank is backed by broad sections of the German population, which tends to save more than other countries and has watched those savings dwindle amid record-low interest rates across the euro zone.

“The ECB really should quickly start a discussion about ending the low rates and bond-buying program,” Stefan Bielmeier, chief economist of Frankfurt-based DZ Bank, told Handelsblatt.

So far, Mr. Draghi has ignored the concerns, pleading for “patience” as he works to repair damage to the rest of the 19-nation euro zone.

His determination is partly perhaps out of a sense of continuity: The central bank only in December decided to extend its bond-buying plan, which amounts to buying tens of billions in corporate and government debt from the private sector each month. The program had been set to end in April after a two-year run but now will last all the way through to the end of the year, though the ECB did agree to slow the pace a little bit from €80 billion a month to €60 billion a month starting in April.

Bundesbank President Jens Weidmann opposed the extension in December and was reportedly angered that Mr. Draghi in a follow-up meeting of the ECB’s decision-making council in January – a meeting where Mr. Weidmann didn’t have the right to vote – suggested there was unity among governing council members.

But Mr. Draghi’s motivation also comes from the inflation data. The ECB has long argued that the increase in prices is temporary, driven by volatile prices like oil and food.

He’s not wrong: Energy prices surged 8.1 percent in January as oil producing states last year agreed to cut production. Food also jumped 3.3 percent. “Core inflation,” which strips out these more volatile goods, rose just 0.9 percent in January. That’s still well off the ECB’s 2-percent target.

That’s something even conservative German economists acknowledge: Joerg Krämer, chief economist of Germany’s Commerzbank and a sharp critic of Mr. Draghi’s policies, admitted the higher inflation is “only” the result of energy prices and will start falling again after February.

There are also huge differences within the 19 countries that make up the euro zone. Germany isn’t actually the worst off. That award goes to Spain, which is seeing its economy recover from a deep recession and saw prices rise 3 percent in January compared to the same month in 2016. France, by contrast, saw smaller price gains of just 1.6 percent.

Central banking sources said these arguments have been enough to keep most members of the ECB’s governing council behind Mr. Draghi.

Still, with inflation rising as it did in January – even if core inflation remained low – there are some who believe Mr. Draghi might start listening to the German concerns later this year. New inflation forecasts to be released by the ECB in March, which will likely show that it expects higher prices this year than it expected in December, will only add fuel to the fire.

“Pressure on the ECB to respond to inflation data is likely to mount. Mr Draghi so far resisted, pointing at the transient element of the spike in inflation. But we believe the rhetoric will gradually change, with the ECB opening a debate on the ‘exit’ as early as June this year,” Gizem Kara, a senior economist with BNP Paribas, said in a note on the inflation figures Tuesday.

That may not be as early as most German economists would like, but it could be a place for the healing to start.


Jan Mallien is a correspondent covering monetary policy for Handelsblatt out of Frankfurt. Christopher Cermak is an editor covering primarily finance and economics for Handelsblatt Global in Berlin. To contact the author: [email protected] and [email protected]