Difficult for the ECB’s Policy Shift to Get Rid of Stagflation Pressures

4 min readMay 17, 2022


President Christine Lagarde of the European Central Bank (ECB) showed on May 11 that the central bank may cease its bond-buying stimulus program in the third quarter of this year and raise interest rates in the coming weeks to combat record-high inflation caused by rising commodity prices. Furthermore, she hinted at supporting the ECB to raise key interest rates in July. Her statement clarifies the ECB’s monetary tightening path and pace, implying that the 10-year quantitative easing program to combat rising inflation will end.

It is a sign that another major economy will follow the Federal Reserve’s tightening policy. In ANBOUND’s view, the ECB’s challenge is bigger than what the Fed is facing. The ECB is struggling with an economic slowdown and a rise in commodity prices under the simultaneous pressures of high inflation and geopolitical threats that are further dragging Europe’s economy into “stagflation”.

Since the beginning of this year, the distortion of the global supply chain, the tightening of the Fed’s policy, and the outbreak of the Russia-Ukraine conflict have worsened the European economy. In fact, the ECB is still injecting cash into the financial system through bond purchases following the Fed’s hiking of interest rates, indicating that there are major hurdles ahead for economic recovery and growth.

The European Central Bank has found it impossible to avoid promoting economic growth because of the delayed recovery of the European economy following the COVID-19 pandemic. In 2021, the Eurozone economy grew by 5.3%, but the economic scale has not returned to the pre-pandemic level. In the first quarter of this year, the Eurozone’s economy grew by 0.2% month-on-month (5% year-on-year), lower than the expected 0.3%, and 0.1 percentage points lower than the 0.3% in the fourth quarter of last year. This suggests that the European economic recovery was already weakening while monetary easing was still in practice. The Eurozone economy’s growth rate is likely to slow further in the second quarter of this year, owing to the Russia-Ukraine conflict and inflationary pressures.

From the month-on-month data, growth in Germany (0.2%), France (0.0%), and Italy (-0.2%), which are the three major economies of the Eurozone, was significantly lower than expected. Meanwhile, Portugal (2.6%) became the country with the highest growth in the first quarter. Inflation in the Eurozone reached a high of 7.5%. In terms of countries, the inflation rate in the major European economies in April was at higher levels, reaching 7.8% in Germany, 5.4% in France, 6.6% in Italy, and 8.3% in Spain. Inflation in the Baltic countries, as well as in the Netherlands and Slovakia, is in double digits. As Lagarde stated, energy prices were the primary reason for excessive inflation in the Eurozone. In April, energy prices in the Eurozone rose by 38% year-on-year, which was the main reason for the increase in inflation that month. Its core CPI (excluding energy and food prices) also soared to 3.5%, well above expectations and above the ECB’s 2% policy target.

This also shows that rising energy, food, and raw material prices have triggered an inflationary trend for consumers. Given the length of the conflict between Russia and Ukraine, and the difficulty of reversing the short-term energy supply distortion, high inflation in Europe has progressed from a short-term factor to a long-term trend. ECB officials are increasingly concerned that the impact of Russia’s invasion of Ukraine will keep inflation high for longer and deepen consumer and business anticipations for higher prices. In addition, as the “scissors gap” between inflation and economic growth widens, if the ECB turns to policy tightening, the pressure on economic growth will be even greater. This will drag the European economy into a quagmire of “stagflation”.

Even if Lagarde is inclined to raise interest rates in July, there are still significant policy differences within the ECB, and officials are still wary of raising rates in the summer. Fabio Panetta, a Member of the Executive Board of the ECB, warned that the Eurozone economy was “de facto stagnating” and said he preferred to wait for the second-quarter GDP data before deciding whether to raise interest rates. These differences are expected to slow the pace of ECB policy tightening, thus making it difficult to contain inflation. In fact, the differences within the ECB reflect the differences in economic development among countries within the Eurozone. These long-standing structural differences make policy changes more difficult. Some countries with higher debt burdens and lower economic capacity are skeptical about their ability to withstand the debt burden and employment pressure caused by the monetary policy shift. These internal structural problems will further widen the gap between the internal inflation situation and economic growth. For the Eurozone, this will further drag down its overall economic recovery.

In response to the Russia-Ukraine conflict, differences within the EU have further divided Europe. As for the ECB, it faces a dilemma. Even if the ECB can start tightening the currency in July, it would still be difficult for the European economy to eliminate the prospect of “stagflation”.

Final analysis conclusion:

As the European Central Bank expects interest rates to rise, this signifies the beginning of a monetary tightening policy. However, based on the current situation, such a policy would still be difficult in eliminating high inflation. On the other hand, tightening policy will harm economic growth, causing the European economy to sink deeper into the quagmire of “stagflation”.

Writer by Wei Hongxu
A researcher at ANBOUND, graduated from the School of Mathematics at Peking University and has a PhD in economics from the University of Birmingham, UK

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