ECB Trapped in its Own “Doom Loop” as Inflation Surges

Trying to keep a financial system and a currency union from collapsing upon each other.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

To the ECB’s barely contained glee, inflation is back, alive, kicking and biting, in the Eurozone. In February, for the first time in four years, the region-wide 12-month inflation rate reached 2%.

Mario Draghi is thrilled to bits. After five years of driving interest rates to ungodly low levels, offering billions of euros of virtually free loans to Europe’s biggest banks, and scooping up tens of billions of euros per month of government and private-sector bonds and stuffing them onto the ECB’s balance sheet, which now holds €3.7 trillion of financial assets, he has finally achieved his dream of stoking official inflation back above 2%.

Now that it’s achieved its inflation mandate, Draghi’s ECB is facing increasing calls to finally begin tempering its monetary stimulus program, with a pre-electoral Germany predictably leading the way.

“It would probably be right if the ECB starts daring to head for the exit this year,” Germany’s Finance Minister Wolfgang Schäuble told the Sueddeutsche Zeitung newspaper (emphasis added). That was in January, when inflation in Germany was still below the 2% mark. Now it’s at 2.2%, its highest rate since August 2012.

In Germany inflation matters a great deal, for two main reasons. First, it is a nation of savers and renters. If inflation rises, so, too, do rents while the purchasing power of the people’s savings falls. And if wages cannot rise as fast as inflation, purchasing power of those wages shrinks.

Second (and probably most importantly), the mere prospect of inflation tends to stir painful collective memories of what happened in 1923, when the country suffered one of the worst episodes of hyperinflation ever recorded. In less than a year, Germany’s currency became worthless. Poverty and hardship spread like wildfire as the value of people’s savings and fixed incomes was completely wiped out.

The psychological scars of this collective trauma live on to this day. When, in May 2012, Schaeuble and Bundesbank economics chief Jens Ulbrich suggested the country could live with slightly higher inflation — at the time it was just above 2% — the daily tabloid Bild screamed an immediate response from its front page: “Inflation Alarm!” Accompanying the headline was a photo of a trillion-mark note from the mid 1920s.




This time, in an effort to head off such fears, the Bundesbank has begun dropping gentle hints that the ECB might want to begin changing course sooner or later. “Once price developments are sustained, they will provide the foundation for an exit from loose monetary policy,” said Jens Weidmann, the Bundesbank’s president. The ECB’s “expansionary monetary-policy path is currently appropriate” given the still-moderate inflation in the 19-country region, he added. That was at the end of January. Since then, inflation has continued to rise throughout the Eurozone.

In Spain it was 3% in both January and February, having almost doubled from the 1.6% rate recorded in December, 2016. The last time it was that high was in October 2012. The biggest mover in January were energy prices, propelled by rising global prices as well as regulatory changes, while in February the biggest driver was food prices, with fresh fruit alone surging 7.6%.

In Belgium the inflation rate is now also on the verge of breaking through the 3% mark. In the Netherlands, the inflation was 1.8% in February; in France and Finland, it was 1.2%, and in Portugal, 1.6%. Even in Italy, whose economy is still threatened by an industry-wide banking crisis, inflation reached 1.6% in February. Four months ago, it was -0.1%.

But the last thing Italy’s government or national central bank wants is for the ECB to begin withdrawing the monetary stimulus. If the ECB stops buying Italian bonds, who will pick up the slack? The answer is no one.

This may explain why Bank of Italy Governor Ignazio Visco is now warning of “higher risks” for the Eurozone resulting from the “accentuation of a climate of uncertainty and pessimism.” In January he urged the ECB to maintain the “highly accommodative monetary conditions,” to ensure “price stability,” by fueling rising prices.

Visco has every reason to be concerned of a change of ECB policy. If the central bank begins tapering, and investors get wind that it is buying fewer Italian bonds, investors will begin selling, triggering downward spiraling prices and rising yields. In a repeat of 2012, Italy’s government will start having difficulty servicing its debt, which will merely serve to exacerbate the sell-off.

Despite the ECB’s QE program, the biggest holders of sovereign bonds are still European resident banks, reports Breugel. In other words, the Doom Loop is still intact, just waiting to be set in motion. In fact, by providing banks with an endless supply of virtually free money with which to buy up obscene amounts of Eurozone sovereign bonds, which ’til now have been backstopped by the ECB’s QE program, the ECB has only amplified the incestuous co-interdependence between sovereigns and their banks. Hence, a sovereign debt crisis instantly become a banking crisis.

In Italy the government now is seeking to expand its own debt in order to bail out Monte dei Paschi di Siena and a clutch of mid-sized banks, whose balance sheets are no doubt filled with Italian government bonds.

In the end, the ECB’s policy isn’t just about creating inflation but about keeping a financial system and a poorly conceived currency union from collapsing upon each other. And now they are more dependent than ever on the constant drip-feed of monetary stimulus. By Don Quijones.

Germany loves physical money and paying with it. This is a big problem for a European establishment desperate to consign physical money to the scrap heap. But the ECB would do so at its own peril. Read…  Are Germans About to Be Made to Pay for Their Love of Cash?




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  11 comments for “ECB Trapped in its Own “Doom Loop” as Inflation Surges

  1. Tom Kauser
    Mar 16, 2017 at 2:08 pm

    I feel like the reserve bank of new york just sent 345large across the pond with plans to continue the flow with more rate hikes openly planned?
    Thank you ma’am my I have another.
    Its another Ibiza sunset tequila is for the Canada goose crowd!

  2. Vespa P200E
    Mar 16, 2017 at 2:45 pm

    No wonder ECB hinted raising rates today…

    I think Janet is behind the yield curve as shown by the perverse market reaction to the long anticipated 0.25% rate hike yesterday. Chinese quickly followed suit and Super (soon to be limp) Mario might not be far behind.

    As for the inflation monster rearing its ugly head – Janet may be forced into accelerating the rate hikes while the economy weakens while waking up from the Trump-menia tiptoeing back to the Great Recession… Any kind of trade or real war in the volatile ME region may spike the oil prices ushering in the STAGFLATION as last stagflation of late 70’s was triggered by OPEC embargo.

    • John Gerty
      Mar 17, 2017 at 10:25 am

      Vespa,
      Beg to differ with you. Recent U.S. oil production gains and the unlikely scenario that tRump would interfere with further production, completely rebalances the OPEC equation. OPEC no longer wields the power it once had. European dependence on Russian natural gas could even be offset somewhat by U.S. gas production. Never mind that fracking may open even more production elsewhere. Sadly, relaxing CAFE standards will hinder U.S. efforts to keep oil consumption at lower levels.

  3. Appolo
    Mar 16, 2017 at 3:50 pm

    Here in Denmark the official inflation rate has not been higher than a percentage point or two for the last couple of decades. I don’t have a shred of doubt that numbers are manipulated. Prices have been skyrocketing from Danish pastries to real state, but salaries are corrected according to gov’t figures. Good bie savings…

  4. unit472
    Mar 16, 2017 at 3:56 pm

    Indeed, ‘inflation’ in Europe is nowhere to be found because of tight labor markets, soaring wages and consumer demand. A cold winter has caused fresh produce prices to soar and with oil back over $50 a spike in fuel costs is being felt. This is not a victory for Draghi but simply a ‘transitory’ rise in prices that will vanish with the spring.

  5. Mike
    Mar 16, 2017 at 3:56 pm

    The one thing I really like about Germany is that rents NEVER spiked like they did in the US in the last 20 years.

  6. Old Codger
    Mar 16, 2017 at 4:05 pm

    Draghi’s ECB, and all the other Central Banks do NOT want 2% inflation, they all want 22% inflation.

    A year later they will want 52% inflation, and the year after, 102 % inflation.

    Then they can start telling lies about the REAL rate of inflation and underpay all the pensions and wages and so on and clear all that debt. They have no other choice apart from default and to cease spending like a drunken sailor.

  7. Vespa P200E
    Mar 16, 2017 at 5:25 pm

    Besides the inflation possibly rearing its ugly head despite the governments of the world massaging/managing the # – could the global CB cabal in unison creeping up the rates now so that they can quickly reduce the rates back to ZIRP and some to NIRP to STIMULATE the potential moribund economies?

    In other words – global CB cabal is merely loading the “ammo” to aid themselves and TBTF banksters.

  8. michael Engel
    Mar 16, 2017 at 5:38 pm

    $EURUST shows that in the long run, after hitting parity area, it will
    move up above the the all time high in 2008, of 1.600.
    The German $DET2y, interest rate is very negative @ (-) 0.797%
    The US $UST2Y rate is 1.332%
    The difference between the two, or the swap, is (+)2.13%. That’s very attractive.
    Money flow into the UST will push the German rates up and the US
    rates down. The swap will shrink !!
    The Fed can continue to raise rates , but the market will
    narrow the swap and the German two years will touch the ZERO
    line, perhaps in 2018.

    The longer terms rates, 10y, 20 &30 years are so low, it indicate
    that the market do not predict inflation in the future.
    What pushed the CPI higher recently is the price of oil.
    But even in the oil market traders do not expect higher oil prices,
    in next few years.
    The Fed stopped the stimulus two years ago. The Fed is leading other
    central banks in raising interest rates.
    Suppose, we will enter a recession & experience a sharp decline of
    the stock markets, both in the US and in Europe.
    Buying solid European stocks, in dollars, in 2017, when the $EURUSD
    is about 1.00, will protect your capital, if the $EURUSD will move up
    to 1.6 (plus the dividends). Despite the collapse of the stock markets. The problem is that the stock prices of the
    solid global European companies, in many cases, are making new
    highs, they are very expensive. But, the currencies rates differential
    will help investor to reach the bottom of the slope, more safely.

  9. Jonathan
    Mar 16, 2017 at 9:18 pm

    In the past 18 years I have seen prices rose by:

    -School bus prices ~5x
    -Higher education ~2x
    -Property prices at least 2x, more in the 3x
    -Food at least 2x, more in the 3x too

    Yup, I can see there’s clearly not enough inflation for the overly entitled clueless know-nothing-better masses, according to the omniscient economists, because you can now buy and eat a smartphone for $50.

    • Dh
      Mar 17, 2017 at 1:07 am

      The i(Big)Mac? :)

Comments are closed.