The monetary forest through which Christine Lagarde and the rest of the ECB are wandering appears to have only one path. During the latest press conference, the ECB President made it clear that the direction of the bank’s interest rate journey is downward.
The famous American poet Robert Frost began his arguably best-known poem, The Road Not Taken, with the following lines:
Two roads diverged in a yellow wood,
And sorry I could not travel both
And be one traveller, long I stood
And looked down one as far as I could
To where it bent in the undergrowth;
Then took the other, as just as fair
Et cetera, et cetera
These lines do not seem to apply to the European Central Bank (ECB). The monetary forest in which Christine Lagarde and her colleagues are walking appears to have only one road. During the latest press conference, the ECB President stated that it is far too early to even consider an alternative course. In Frost’s terms: according to Lagarde, no other path will be visible for a long time.
Many in the ECB’s governing board share this view. The Italian board member, for instance, recently stated that economic weakness in the eurozone is more persistent than expected, mainly because household consumption has yet to recover. The President of the French central bank remarked in a speech that US interest rates could impact growth. Inflation as well, but his emphasis was on growth. Both statements suggest that ECB rates should be lowered further.
However, not everyone agrees with the ‘further cuts’ faction. The Belgian central bank chief indicated that the ECB should be cautious about lowering rates too much and should be prepared to halt its rate-cutting process soon. He appears to glimpse a side path emerging in the monetary forest.
Meanwhile, Isabel Schnabel, the German member of the ECB’s executive board, seems to see a veritable Autobahn! The Frankfurt-based bank must now start discussing a pause—or even a complete halt—to rate cuts, Schnabel recently stated. She spoke of upward inflationary pressure.
Growing dissent
In short, disagreement over the ECB’s course is increasing. Does this mean the bank will actually change direction? No, it does not. The sensible faction is very small, while the Lagarde group is much larger—especially now that the German Bundesbank also appears to have joined this camp. Even Joachim Nagel, President of the German central bank, recently spoke up in favour of further rate cuts.
The path that the ECB has been following for some time—and will continue to follow—seems to be leading the eurozone towards a kind of Latin monetary union, or in other words, a Franco-Italian euro with the accompanying sluggish economy.
The Italian central banker, who spoke of weaker-than-expected economic conditions due to the lack of a recovery in household consumption, neglected to address the question of why consumption is not recovering.
A major reason is that inflation in the eurozone has been far too high for years—partly because the ECB has failed to tackle excessive inflation decisively since 2021, instead repeatedly assuring that the situation will soon improve. Excessive inflation inevitably weakens an economy; economic history teaches us this. If that were not the case, Italy—given the country’s inflation record since the end of the Second World War—would be an economic superpower. And yet, there are policymakers and economists who advocate for a higher inflation target.
Eurobonds
There is more evidence pointing to this as the final destination. The European Commission wants to finance various expenditures—particularly on defence and infrastructure—through eurobonds, or joint government debt. Now, you may guess three times which monetary policy would complement that plan.
Or take French President Emmanuel Macron, who recently stated that European fiscal rules are redundant. These rules are a fundamental pillar of the euro. In practice, the rules already carry little weight, and now Paris is advocating their outright legal abolition. The deafening silence from other eurozone countries in response to this proposal was striking. Does silence imply consent?
Frost wrote in his poem that choosing a path inevitably leads to other roads further along: «Yet knowing how way leads on to way, I doubted if I should ever come back.» In this way, the traveller is highly unlikely to return to the original crossroads.
Frost concluded his poem with:
I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I—
I took the one less travelled by,
And that has made all the difference.
In my view, the ECB is choosing the wrong monetary path. And that, I fear, will indeed make a difference—a very significant one, possibly even leading to the disappearance of the common currency at some point in the future.
Edin Mujagić is an economist, fund manager at Beleggingsfonds Hoofbosch, and author of the book Keerpunt 1971. Every month, he writes an ECB Watch column on the European Central Bank’s monetary policy for Investment Officer.
