Despite growing efforts to increase transparency in developed countries, monetary policy continues to exude an aura of mystery in many respects. Although interest rate movements are made public instantly, the truth is that no one knows for sure what happens at each meeting (the published minutes are usually a summary ad hoc) and even less the real information available to central bankers. One of their tasks in bringing inflation to target is to generate expectations, that is, even if they know that the economy will collapse or that inflation will rise arrow, part of their mission is to prevent these expectations from happening. In a somewhat crude and exaggerated way, it can be said that a central banker can lie to you until the lie is no longer tenable, but that is part of his job. As a very clear example of this dynamic, the European Central Bank (ECB) has for years ensured that its rate decisions are not linked to oil or energy…however, There is a chart that seems to say just the opposite..
In 2021 and part of 2022, the ECB’s speech has been clear: the rise in the price of inflation is caused by the rise in energy prices (especially oil) and is temporary, therefore increase inflation rates. interest has no meaning. They also noted verbatim that “higher interest rates would not lower energy prices.” The various officials of the ECB, like other colleagues of their Western peers – see those of the American Federal Reserve -, have affirmed in their appearances in the media and on forums that it is necessary to concentrate on inflation underlying, because the volatility that has taken place in recent years Mid-century, they have experienced energy prices that have not allowed us to see the forest well.
Some experts such as those from the analysis house Oxford Economics have put together this theoretical thought pattern of central bankers as follows: “1) The rise in inflation will be temporary and the surge in energy inflation will have dissipated before monetary policy has had a significant impact on activity and prices. 2) Rising energy prices generally act as a tax on the economy and reduce economic growth, and therefore underlying inflationary pressures, beyond the short term. And 3) the secondary inflationary effects of rising energy prices tend to be small and limited to a few sectors, like airlines, where oil prices have a huge impact on costs. » Come on, energy has almost nothing to do with the movements of a central bank.
However, economists at Deutsche Bank believe this is not the case. A few weeks ago, Jim Reid, Global Head of Economics and Research theme of the German entity, sent its clients an oil graph on which the most important movements of the ECB since its creation were superimposed. This economist, who is Deutsche Bank’s “star” strategist, assured that “To understand the path forward for the ECB, it is helpful to take a look at the chart which Francis Yared (another Bank of Germany economist) has used over the years, and which shows how the annual change in oil prices has generally been a determining factor in the ECB’s policy changes.
Reid also mentions an article by his colleagues Peter Sidorov and Mark Wall in which he emphasizes “To what extent ECB policy has been linked to oil in recent years“And given the great uncertainty that currently exists regarding the price outlook, particularly given geopolitical uncertainties, it is not surprising that the ECB wants to keep its options open.”
The ECB publicly assures that energy does not determine its monetary policy, but the facts seem to say the opposite. It is true that an inflationary shock caused by energy should not change inflation in the medium term, but if this shock lasts longer than expected, experience shows how oil ends up filtering into all layers of the economy. inflation to the point of generating the risk of the appearance of an inflationary shock. price-wage spiral, as we saw this last time.
This is how oil seeps into the rest of the economy
Oil is an essential element in the production of energy, the transport of goods and people and the production of certain by-products, such as plastics and fertilizers. When the price of oil increases, as it did during the 2021-2022 period, energy costs immediately increase, making the transportation of raw materials and finished products more expensive. Until then, the ECB would be right and the rise in inflation would remain temporary. However, if crude oil prices do not fall immediately, it will eventually increase costs for businesses in sectors such as manufacturing, agriculture and trade. To protect their profit margins, companies pass these higher costs on to the final prices paid by consumers, thus leading to initial inflation.
When prices rise steadily due to rising oil prices, workers They usually start demanding salary increases to protect their purchasing power.especially in environments like the current one where labor markets are very tight. If businesses agree to these demands, labor costs rise, reinforcing inflationary pressures. This phenomenon, known as the second-round effect, can lead to the feared wage-price spiral that consolidates inflation at higher levels. Furthermore, economic agents’ expectations regarding future price increases may be anchored at high levels, thus perpetuating the inflationary cycle.
Thus, as oil affects a wider variety of sectors, inflation ceases to be an energy-specific phenomenon and becomes a broader, more structural problem. Widespread price increases mean traditional containment measures, such as interest rate increases by central banks, may be less effective. Indeed, inflation no longer responds only to short-term imbalances in supply and demand, but to profound changes in the structural costs of the economy.
A look back at the oil-BCE idyll
Although the history of the ECB is brief in historical terms, this quarter century or so serves to corroborate the trend. The first episode dates back to 1999 and 2000, when the central bank had just started. If in the spring of 1999 the deposit rate was 1.5%, then began a cycle of increases which intensified in 2000, bringing this rate to a maximum of 3.75% in October of the same year. It is precisely at this period, the barrel of Brent, the benchmark crude oil for Europe, went from 15 dollars to exceed 35 in August 2000. The other side of the coin was experienced the following year. The barrel fell from this peak to $19 and the ECB reduced the deposit rate to 2.25% in November 2021.
The phenomenon was seen even more clearly in 2005. That summer, the barrel of Brent jumped from 40 dollars to nearly 67. In December of the same year, the ECB began a cycle of increases which began with the deposit rate at 1.25% and which ended in the summer of 2007 with a rate of 3%. During the same period, oil had already threatened to break the $90 resistance.
More significant and memorable is the case of 2008, nicknamed the “first Trichet error”, in reference to the president of the ECB at the time, Jean Claude Trichet. At the July meeting of that year, when the Great Financial Crisis was in its eleventh month and the economy was crashing, as this article from elEconomista.es, The ECB has decided to increase the price of silver by 25 basis points.
The argument put forward by Trichet and his colleagues was that inflation was 4% year-on-year in mid-2008, double the central bank’s target. Needless to say, in June 2008, oil, under the leadership of China which, a few years earlier, had begun to import it massively, reached the scandalous level of 138 dollars per barrel. The immediate collapse of crude oil prices to $35, which marked the final implosion of the crisis, was followed by a crushing cycle of ECB rate cuts that brought the deposit rate to a meager 0, 25% in May 2009.
In 2011, the second “Trichet error” occurred, perhaps the most infamous. With the Eurozone already open due to the debt crisis, the ECB raised rates in two consecutive meetings, in the summer and spring. At that time, yields on peripheral bonds were soaring (Spain, Greece and Portugal were struggling to find demand in the markets), but fears of a resurgence in inflation led Trichet to raise interest rates in July 2011 to try to calm the recent rise in inflation. which rebounded in the heat of the rise in oil. China not having suffered the blow of the great crisis like the West, the Asian giant continued to buy oil and Brent recovered to 126 dollars, just before the second “error” of the French banker.
The resounding change of record that marked the central bank’s changing of the baton in favor of Mario Draghi also showed measures that tracked the oil score. The arsenal deployed by the Italians in 2015 and 2016, not only the rate cuts, but the ambitious quantitative recovery program (QE, purchases of sovereign bonds), followed two brutal declines in Brent, to 47 dollars in January 2015 and up to 33 at the beginning. from 2016. The big trigger was the takeoff in the United States of the technique of hydraulic fracturingwhich potentially increased supply. The prices of “black gold” fell as soon as the rapid and expected reaction of Saudi Arabia, the major “producer”, arrived: flooding the market with crude oil in an attempt to overthrow these American companies. At the same time, Draghi’s ECB began to scale back its stimulus measures when Brent prices returned to around $80.
Advancing almost to the present, the collapse of oil due to the initial covid epidemic in the West in 2020 – even negative prices were recorded on the futures markets – had its response from the ECB in the rollout of the program pandemic bond purchase (PEPP)) with Christine Lagarde already in charge: no more stimulus – a real bazooka – with some still negative. How, the other side of the coin would be visible after two years. The rigors of the Russian invasion of Ukraine – energy uncertainty on a global scale – have caused the price of oil to skyrocket, with the barrel once again surpassing $120 as summer approaches. A summer in which the ECB began to follow an aggressive path of rate hikes and the end of stimulus measures that only began to be reversed in recent meetings.
The drop in the price of oil, currently listedto 71 dollars, allows the ECB to lower interest rates with the certainty that inflation will not return, at least in the short term. The crude oil market finds itself in a somewhat contradictory period: while The offer is at its maximum and demonstrates great solidity (this is a bearish force for crude oil), geopolitical risk is also at historically high levels. For now, supply strength is dominating, which has led crude oil into an intense correction since hitting $120. Meanwhile, the ECB will continue to lower interest rates.
