ECB criticised for hesitant rate hikes that fueled inflation, study claims

The European Central Bank was yesterday lambasted for dithering over interest rate rises that helped fuel eurozone inflation, according to a new study by the German Institute for Economic Research.

The ECB study, reviewed exclusively by Reuters, said that earlier and more forceful increases in key interest rates from mid-2021 could have restricted inflation to no more than 3 per cent-a far cry from the over 10 per cent peak reached in August 2022. The ECB started raising interest rates only in July 2022, having ended an unusually long period of zero interest rates, while many central banks had already begun to tighten monetary policy.

The ECB was rather idle to begin with, particularly when inflation went through the roof following Russia's invasion of Ukraine in February 2022. "The reasons cited by the ECB for its sluggish response was that its monetary policy could not affect energy prices," Schumann said. "But this is wrong because our observations show it could have cracked down on the last wave of inflation at its roots."

This would have resulted in an earlier rate hike, which would suppress the energy demand in the eurozone, affecting the global prices of energy. Furthermore, had higher interest rates been implemented more quickly, then the euro would most probably have risen more strongly against the dollar, which again would have helped in reducing the energy costs, most of which appear in the global markets being denominated in US dollars.

While many ECB policymakers have conceded that the central bank could have been more aggressive in raising interest rates and should have done so earlier, they point out that it was enough to make large corrections that included successive multiple 75 basis point increases late in 2022. The ECB had essentially raised its deposit rate from minus 0.5 percent to a record 4 percent by the end of summer 2023 after ten consecutive increases.

Schumann said a more aggressive interest rate stance from the Central Bank would have posed another challenge to the inflationary shock and signaled a stronger commitment towards fighting inflation, thereby mitigating sharper price jumps in the wake of the war breaking out in Ukraine.

The eurozone's inflation, peaking above 10 has been among the highest in developed economies, while that of the U.S. topped 9.1 percent and for the UK over the same period reached 9.6 percent. Much of Europe's inflation increase is explained to analysts as because of its heavy dependence on imported energy.

The DIW study results indicate that starting to hike interest rates a bit earlier the central banks might have shaved off 3 percentage points in eurozone GDP . However, the economy could recover by the end of 2023. While the ECB finds itself while migrating its monetary policy strategy, the debate over previous decisions and the long-term effects of the policies continues to build up on the inflation front.