Interest rate hikes may become political problem for European Central Bank

Tensions are likely to build between euro zone governments and the European Central Bank (ECB) in the weeks ahead. Figures published on Monday showed a surprise fall in German gross domestic product in the final quarter of last year which is likely to signal stagnation, or a small fall, in output for the bloc as a whole. Despite this, the ECB has indicated that it will increase interest rates by half a point on Thursday and by the same amount again in March. The central bank will plead that it has no alternative if it is to stop inflation becoming entrenched; many euro zone politicians will think otherwise. Gentle questioning of the ECB strategy could quickly turn into something of a standoff.

[ ECB policymakers lay bare differences over further interest rate hikes ]

Of course, the ECB has its mandate and it is not charged with being popular. But the traditional role of a central bank – to take away the punchbowl just as the party is getting going – presupposes that interest rates are increased to stop runaway demand pushing inflation higher. This time around, economic conditions are weak across much of the euro zone, even if the threat of a deep recession seen as likely a few months ago may not have passed.

Germany, with its traditional caution on inflation, may not criticise the ECB. But Italy’s new government has already done so and there have been rumblings too from France, where President Emmanuel Macron warned last year that the ECB risked “shattering demand” by moving too quickly. Politicians may live with this week’s increase, which would take the ECB deposit rate to 2.5 per cent, but indications that this rate could be increased by another full percentage point by early summer will not go down well.

[ ECB to ‘stay the course’ on high interest rates, Lagarde warns ]

With wholesale energy prices easing, governments may soon be able to point to a rapid fall in headline inflation to bolster their case that the ECB should not tighten too fast. But the central bank remains worried about inflation spreading more widely – core inflation, excluding food and energy, remains stubbornly high – and about wages picking up. The danger for the ECB is that the data does not support its strategy in the months ahead but it appears determined to move ahead quickly with rate increases in the first part of the year no matter what.