The German Institute for Economic Research (DIW) has issued a warning regarding the dangers facing the economy following the ECB’s decision to keep key interest rates unchanged. Marcel Fratzscher, head of the DIW, described the ECB’s decision to maintain a pause in rates as “understandable, but risky,” stating that inflation has risen significantly and risks are still pointing upward.
He pointed out that the ongoing war in the Middle East and rising energy costs could cause inflation next year to be higher than currently anticipated. Fratzscher further anticipates that the ECB will be compelled to revise its inflation forecast upward in December.
While acknowledging the difficulty of the situation, the DIW chief admitted that there are currently no clear indicators of significant secondary, or second-round, effects. He noted that there are no definite signs of a self-reinforcing wage-price spiral found either in corporate profits or in wages. Additionally, core inflation has increased less sharply than overall inflation.
However, the primary concern, according to Fratzscher, lies with inflation expectations, which stand at 2.5% over five years-significantly above the ECB’s 2% target. This discrepancy poses a danger that elevated expectations could become entrenched, thereby undermining the credibility of the ECB.
Fratzscher understood the ECB’s inclination to wait for additional data before acting. Nevertheless, he cautioned that failing to increase rates now could prove to be a mistake. He argues that a rate hike would send a clear signal that the ECB is resolutely defending its inflation target. Conversely, he opposes an immediate increase, explaining that the current tumult in bond markets has already tightened financing conditions, which further dampens the already weak economic recovery.
Ultimately, the ECB finds itself in a difficult dilemma: as Fratzscher summarized, “acting too quickly could unnaturally weaken the economy, while waiting too long risks cementing inflation expectations.”
