War in Ukraine, galloping inflation, serial shortages… While the summer promises to be difficult for the European economy, a new twist has added another shadow to the picture: the resignation of Italian Prime Minister Mario Draghi , the 14th of July. Admittedly, the country’s president, Sergio Mattarella, has so far refused it. Still, the departure of the man who has been dubbed the savior of the euro could throw Italy into a political crisis that could complicate the mission of the European Central Bank (ECB) a little more – than Mr. Draghi, ironically history, chaired from 2011 to 2019.

The institution, whose governors meet Thursday, July 21, is now facing an insoluble equation: to fight against soaring prices, without breaking an already fragile growth. Because, in recent months, inflation has taken a worrying turn in the euro zone. In June, it peaked at 8.6%, mainly fueled by the rise in energy prices (41.9%), but also food (8.9%) and services (3.4%). ).

The weakness of the euro, which has lost 10% of its value against the dollar since the start of the year – the two currencies are now at parity – is pushing prices up a little further. “Anything imported costs more,” sums up Eric Dor, an economist at the Ieseg business school. This is largely due to the differences in monetary policies between Europe and the United States. To counter inflation, the Federal Reserve (Fed, American central bank) has already vigorously raised its key rates – they are fluctuating between 1.50% and 1.75%. The ECB deposit rate is still negative (-0.5%). Result: investors are leaving the Old Continent to seek better yields on the New York Stock Exchange, which further weakens the euro against the greenback.

“The worst-case scenario seems to be falling into place”

To make matters worse, the economic panorama continues to darken on this side of the Atlantic, while Europe must urgently learn to do without Russian gas, while shortages of materials affect a part of the industry. “The economy of the monetary union should soon enter a recession”, predicts Jack Allen-Reynolds, at Capital Economics. He considers the European Commission’s growth forecasts (2.6% in 2022 and 1.4% in 2023 for the euro zone) too optimistic. “The worst-case scenario seems to be in place for the ECB,” fears Eric Dor. Namely stagflation, a cocktail of weak growth and inflation. Or even “decline inflation,” when gross domestic product declines amid soaring prices.

In an attempt to curb the latter, the ECB has made it widely known in recent weeks that it will raise its key rates by 0.25 points on Thursday. “The first rate hike since 2011 was so well pre-announced that the markets could have the same reaction as children who already know the contents of the presents under the Christmas tree: disappointment,” quips Carsten Brzeski, economist at ING. “The ECB is a bit behind the Fed,” the analysts at Capital Economics add – although they believe it will likely kick in a boost in September, with a 0.5 point hike. At the risk that this weakens an already feverish growth, because the rise in rates increases the cost of credit for households and businesses.

Only, here it is: will this remedy against soaring prices be effective, knowing that this is largely linked to energy tariffs, and therefore imported? One thing is certain: the action of the ECB will have no effect on the volume of hydrocarbon production or on the gas blackmail exerted by Vladimir Putin on the West. But since its inflation target (2%) has been largely exceeded, it is forced to act to remain credible. “It seeks above all to influence the expectations of economic agents,” explains Eric Dor. That is to say, reassure companies considering passing on higher costs to their rates and unions demanding increases. This, to prevent the euro zone from plunging into a self-sustaining spiral, where rising wages fuel rising prices, and vice versa.

“Structural Problems of the Eurozone”

On Thursday, the Frankfurt institute is also expected to present at least some details of its long-awaited “anti-fragmentation tool”, intended to prevent the spread between the rates of different countries borrowing on the markets (the “spread”) from increasing by excessive and unjustified way. “As with every crisis, the ECB is faced with structural problems in the euro zone”, analyzes Eric Dor. Namely, the divergence of economic situations between member countries, a pretext for market speculation when the situation becomes tense.

Today, the spread between Italian and German ten-year rates is moving to almost 224 basis points (2.24 percentage points), compared to 135 points at the beginning of January. At the height of the European debt crisis in late 2011, it peaked at over 512 points as speculators went wild on Italian bonds, jeopardizing the very integrity of the eurozone. It was then necessary for Mario Draghi to promise that he would do “whatever it takes” to save the single currency, in July 2012, then to mention a tool for buying back public debts (the OMT), to put out the fire on the steps.

To prevent such a scenario from happening again, the ECB is therefore working on a new mechanism of this kind. “It will need to be bold, flexible and credible enough to prevent a sustained rise in spreads,” Frederik Ducrozet, head of economic research at Pictet WM, said in a note on the subject. According to him, this tool should also ideally be unlimited in size and subject to relatively light conditions – for example, the implementation of the reforms already planned under the European recovery plan NextGenerationEU, adopted at the beginning of the Covid-19 pandemic.

But how do you know if the widening of the spread is normal – healthier countries pay less for their loans – or unjustified, because it is caused by excessive speculation? “It’s practically impossible,” Bundesbank boss Joachim Nagel said on July 4 in a speech. Like many in the Nordic countries, he fears that the ECB’s anti-fragmentation tool will grant a blank check to countries whose public finances are considered too lax. “Perhaps, but too strict conditions would make such a mechanism ineffective, analyzes a good connoisseur of the institution. ECB President Christine Lagarde will have to spare the goat and the cabbage to find a compromise: once again, the future of the eurozone is at stake.”