The ECB faces an excruciating dilemma. Eurozone inflation jumped to 10.7pc in October and has yet to peak. The stagflation misery mix is no worse than in the UK – and no better either – but the political implications are profoundly different within the structure of the euro.
German inflation has reached 11.4pc on the Eurostat measure, the highest since the Korean War in 1951. It is significantly higher than the brief 8pc peak during the energy crisis of the 1970s when the Bundesbank – almost alone among the Western central banks – opted early for recession to break the back of inflation.
The founding contract of the euro was that the ECB should be as rigorous as the Bundesbank, and the euro should be as hard as the D-Mark. That contract looks like a quaint relic today. But it would be tempting fate to assume that Germany will tolerate double-digit inflation for long, or that it will allow the ECB to keep tilting policy towards the needs of Club Med debtors in the cause of euro solidarity.
The German economic establishment thinks the country is on the cusp of a wage-price spiral. Workers from 12 big industrial companies went on strike over the weekend as a warning shot. The trade union giant IG Metall is demanding an 8pc pay raise and is threatening a very un-German winter of discontent. Public sector workers recently asked for 10.5pc.
There is an even deeper problem of social cohesion. Inflation is toxic in Germany because of deep-rooted cultural traditions. Half of Germans rent rather than own property. They typically keep their savings in bank accounts, and have no financial assets. They have entirely missed out on the compensating wealth gains of the last decade. Gefühlte Inflation – the inflation that shoppers feel – is running at twice the official CPI rate.
A study by the German Economic Research Institute found that the real disposable income of the poorest decile dropped 8pc from 1995 to the onset of the pandemic in 2020. The second decile had seen no rise in a quarter century. These figures will be much worse after Covid and Putin’s commodity squeeze.
Volker Wieland, a former member of the German Council of Economic Experts, said inflation had reached the point where nothing short of sharply positive real rates will be enough to break the fever. “Inflation is going to become entrenched unless the central bank acts,” he said.
Positive real rates are precisely what Italy cannot endure. It is why premier Giorgia Meloni lashed out at the ECB on her first day in office, denouncing rate rises on the cusp of recession as precipitous.
She said ill-timed monetary tightening would choke credit to families and firms, and she complained that halting bond purchases creates “extra difficulties for member states with high public debt” – as indeed it has.
The borrowing cost on Italian 10-year bonds has risen by 135 basis points to 4.28pc since August. The risk spread over German Bunds has widened to 217 basis points. It is as if the weakest member of the team must carry a double pack up the mountain.
Mrs Meloni is now in implicit alliance with France’s Emmanuel Macron, who has also castigated unnamed monetary hawks at the ECB. His demarche is logical: France has an even bigger debt burden than Italy.
Data from the Bank for International Settlements shows that total public and private debt (non-financial) is 351pc of GDP in France, up 70 percentage points over the last decade. The comparable figure is 276pc in Italy, and 271pc in the UK, and 199pc in Germany.
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