When the European Central Bank, as expected, raises interest rates on 11 June, it will be acting partly to exorcise the ghosts of inflation past.
With a probable 0.25 percentage point increase in its 2% key lending rate, the ECB is signalling a purchase of monetary insurance against an Iran war-induced inflation spike feeding through durably into greater price pressures. But it is also taking an incisive – and, we must hope, not too risky – step to atone for past mistakes: notably, failure to take seriously the inflation surge in late 2021 and the first half of 2022.
There are powerful economic, political and psychological reasons at play as to why the ECB might be correct to act now. But there is also a far from negligible chance that that the anticipated rate rise could turn out to be a mistake. The European economy is flat-lining. Germany, the continent’s strongest economy, has been stagnating since 2018 – by far, the longest phase of low growth since the country’s post second world war rebirth, and unusual even against the volatile standards of the 1920s and 1930s. And there are few signs that the rise in euro area inflation to 3.2% in May 2026 is about to unleash a wage-price spiral.
‘De-anchoring’ inflation
Among the most prominent reasons for hiking now is the notion that consumers remember the inflation unleashed four years ago by over-easy monetary policy, the ending of the Covid-19 pandemic and the outbreak of the Russo-Ukrainian war. So, ECB experts say, inflation is far more likely to become ‘de-anchored’ this time around than in 2022, when previous experience of similarly elevated inflation had been 30 or 40 years earlier.
Policy-makers may wish to show – with a watchful eye on the (so far gloriously counterproductive) assaults on Federal Reserve independence by President Donald Trump – that they are not afraid of taking unpopular decisions.
Nipping in the bud
On the other side of the Atlantic, long in the tooth (and long retired) central bank economists such as William ‘Bill’ White and Charles Goodhart have claimed that central banks will be reluctant to hike rates for fear of causing higher borrowing costs for over-indebted governments. The ECB may want to prove these august veterans wrong – and underline that nipping inflation in the bud is the best way of preventing rises in long-term interest rates.
Furthermore, they may wish to demonstrate to a possible future far-right French president that the ECB will not be a push-over. Jordan Bardella, the youthful president of France’s National Rally (RN), current frontrunner in the incipient election contest to decide in April 2027 the successor to President Emmanuel Macron, has flirted with asking the ECB to buy French bonds to lower borrowing costs. The suggestion was quickly withdrawn. It became clear that, if it transpired, the French state would have to submit to draconian ECB conditions. But that may not stop the idea from resurfacing next year.
ECB president contest
The biggest reason for a rate rise may however be the ECB’s collective mood of mild embarrassment over the errors of 2021-22. Joachim Nagel, Deutsche Bundesbank president, is one of the candidates to take over from Christine Lagarde, residing president of the ECB, when she leaves at the latest at end-October 2027. He has been (predictably for a Bundesbank chief) foremost among those declaring the possible need for tighter money.
As a newcomer to the ECB governing council in January 2022, in his first speech as Bundesbank president, he presciently emphasised the risk of inflation (then running at 6% in Germany) remaining elevated for longer than forecast. And he was a key figure engineering the belated (first of many) interest rate rise (from then negative rates) in July 2022.
The ECB’s misjudgement on the ‘transitory’ nature of inflation (both pre- and post-Russian invasion) was shared by other central banks including both the Fed and Bank of England. But it was crystallised in Lagarde’s December 2021 statement (when euro area inflation was close to 5%) that, ‘under the present circumstances, it is very unlikely that we will raise interest rates in the year 2022.’ She later admitted, ‘I should have been bolder’, that the ECB had been wrong in its earlier commitment not to start raising interest rates until it had stopped buying bonds through its pandemic crisis quantitative easing programme (phased out gradually in the first six months of 2022).
These episodes will be in policy-makers’ minds when they make the interest rate decision on 11 June. So too, although less clear-cut, will be the shadow of two previous periods when the ECB erred in raising interest rates at the wrong time – in July 2008 (the more unfortunate and less forgivable occurrence) and in April and July 2011.
For the time being, the discomfiting collective memory of 2021-22 represents the dominant force governing the ECB’s choice. Future developments will show whether it was justified.
David Marsh is Chairman of OMFIF.
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