The inflation rate in the euro area is higher than ever. The ECB President recently announced an end to the negative key interest rates. But what is the best way to proceed?

The debate about the appropriate response to high inflation in the euro area is gaining momentum. Several high-ranking central bankers commented on the subject on Wednesday.

This shows that there is far from agreement in the Monetary Policy Council of the European Central Bank (ECB). While some monetary authorities advocate a bold approach, others advocate a more cautious approach.

At the beginning of the week, ECB President Christine Lagarde set the basic line by promising an end to negative key interest rates by late summer. Since the rate for bank deposits at the ECB is currently minus 0.5 percent, Lagarde’s proposal results in a rather leisurely pace of tightening with small interest rate increases of 0.25 percentage points, probably starting in July. The French left the subsequent course from autumn open.

Normalization at the «other than normal time»

However, this approach is not enough for some central bankers. The central bank heads of Austria, the Netherlands and Latvia have been the clearest so far. Austria’s first currency guardian, Robert Holzmann, had already voted on Tuesday for a major interest rate hike of 0.5 percentage points at the start of the monetary policy turnaround in July. On Wednesday, the head of the Dutch central bank, Klaas Knot, said that such a step was “not off the table” despite Lagarde’s specifications. The governor of Latvia’s central bank, Martins Kazaks, took a similar position.

However, headwind comes from ECB officials who are more inclined towards a loose monetary policy – such as ECB Director Fabio Panetta. “Like other major central banks, we are faced with the task of normalizing monetary policy at a time that is anything but normal,” Panetta said in Frankfurt on Wednesday. The central bank is faced with an unprecedented series of economic shocks, said the Italian, for example with a view to the war in Ukraine. In this difficult situation, a gradual streamlining is recommended.

Comments by Finland’s central bank chief Olli Rehn, who also called for a cautious course and a small first interest rate hike in July, went in the same direction. Meanwhile, ECB Vice President Luis de Guindos remained neutral. He underscored the ECB’s fundamental approach of aligning monetary policy with economic developments. “Let’s wait and see what happens,” the Spaniard told the news channel Bloomberg TV.

Not comparable to USA

In an international comparison, the ECB is taking rather slow action against the inflation that has been high for months. In the euro zone, inflation recently rose to a record 7.4 percent. An important reason is the economic impact of the corona pandemic on world trade, which is being intensified by the war in Ukraine. While other central banks, such as the US Federal Reserve, have already raised their key interest rates several times, and in some cases significantly, the ECB is still hesitant about raising interest rates. However, it has already scaled back its purchases of securities to support the economy.

The ECB often justifies its cautious approach by saying that the situation in the euro area cannot be equated with the situation, particularly in the USA. For example, Europe is more severely affected by the economic effects of the Ukraine war. Wage increases and the inflationary risks they emanate are also much more pronounced in the USA than in the euro zone. Nevertheless, critics complain that the ECB is lagging behind other central banks such as the Federal Reserve or the Bank of England in fighting inflation.