The European Central Bank's monetary policy faces new challenges, and this time the bad news does not come from Greece, Italy, or the poorer countries in southern Eurozone, but from the engine of the European economy—Germany.
Affected by a series of adverse factors, such as weak trade with major partner China, significant downturns in manufacturing and construction, and high energy prices caused by the Russia-Ukraine conflict, Germany is hindering the growth prospects of the entire Eurozone and may drag the Eurozone into recession. This could force the European Central Bank to change its current inflation-control monetary policy.
The market believes that the European Central Bank may have to end its rate-hiking process soon, similar to the tightening cycle in 2011. At that time, the debt crises in Greece, Portugal, Ireland, Spain, and Cyprus posed a risk of collapse to the entire Eurozone economy. Richard Portes, an economics professor at the London Business School, mentioned that the European Central Bank now faces some similarities to the problems of 2011.
Different from the previous tightening cycle, this time the threat to the European Central Bank's monetary policy does not come from southern Europe or second-tier countries but from Germany, the leader of the Eurozone economy. Ralph Solveen, an economist at Commerzbank, indicates that if the government does not take decisive action, Germany is likely to continue to rank at the bottom of the Eurozone's economic growth.
Although Germany's sluggish economic growth is influenced by factors such as the energy tensions triggered by the Russia-Ukraine conflict and the shrinkage of demand from China, deeper reasons include Germany's excessive dependence on exports, lack of investment, and labor shortage.
Indeed, the monetary policy of the European Central Bank is also a primary reason for Germany losing its former glory. The European Central Bank intentionally suppressed economic activity by raising interest rates, attempting to bring last year's inflation rate, which once reached double digits, down to a target of 2%. The rise in borrowing costs is particularly damaging to the manufacturing sector, and no country's industrial sector in the Eurozone can surpass Germany's.
Portes suggested that it would be unwise to relax monetary policy due to Germany's difficult situation, but continuing to tighten monetary policy will inevitably further damage Germany's economic growth prospects. Germany's current economic performance puts the European Central Bank in a dilemma; on one hand, higher levels of inflation prevent the bank from immediately stopping its tightening monetary policy. On the other hand, further tightening of monetary policy will make Germany's economic outlook even more pessimistic, even pushing Germany into the abyss of recession.
Ricardo Reis, a professor at the London School of Economics, suggests that the European Central Bank needs to focus on the inflation expectation path "12 or 18 months ahead" as it has done in the past, rather than current inflation data.
Recent data showing the inflation rate, excluding energy, food, alcohol, and tobacco, fell to 5.5% after, some European Central Bank officials hinted at pausing rate hikes. Christine Lagarde, the President of the European Central Bank, mentioned there is not much more the European Central Bank has to do at this time, and ECB executive board member Fabio Panetta suggested maintaining high-interest rates, rather than further hikes.
Although the European Central Bank may continue to hint that rate hikes could resume if necessary, recent remarks by some European Central Bank officials have laid the groundwork for a pause in rate hikes in September.
