K. Lagarde: We will look at inflation higher

By Leonidas Stergiou

Four factors that threaten higher inflation and lower growth remain, while a root cause of inflationary pressures has not yet normalized, as expected. These are supply problems and supply chain shortages. Added to all this is the impact of the Russo-Ukrainian war, which, according to Ms. Lagarde, predicts even higher inflation.

3 + 1 sources of concern

According to her speech today at the Central Bank of Cyprus, three key factors are likely to lead to a larger rise in inflation, which according to Ms. Lagarde are:

First, energy prices are expected to remain higher for longer periods, and indeed gas prices have risen by 52% since the beginning of the year and oil prices by 64%. Similar price pressures have been recorded in Cyprus and inflation has risen to 5.8% – mainly due to higher energy and food prices (26.2% and 6.8% respectively).

Second, pressures on food price inflation are likely to increase. Russia and Ukraine export almost 30% of the world’s grain, while Belarus and Russia account for about a third of the world’s potash production, a key ingredient in fertilizer production, which exacerbates supply shortages.

Third, global manufacturing congestion is likely to persist in some areas. Russia, for example, is the largest exporter of palladium, which is a key element in the production of catalysts. Ukraine has about 70% of the world’s neon gas reserves, which are absolutely necessary for the construction of semiconductors.

Finally, war poses significant risks to development.

Regarding the problem of the resumption of the economy caused by the spring effect on inflation, Ms. Lagarde noted that “it was not so easy to restart supply after the restrictive measures to curb the virus.” This caused a global mismatch. between sharply increasing demand and limited supply, which has led to shortages and disruptions in the supply chain.

As she explained, given the degree of interconnection of the world economy, this phenomenon was transmitted in chains from one market to another, creating strong inflationary pressures. He even gave the following example: Since last June, energy and food account for, on average, about two thirds of inflation in the euro area. This partly reflects OPEC’s decision to reduce crude oil supply by 9.7 million barrels per day in 2020 and, subsequently, the fact that some of its members have not restored supply to its previous levels. This in turn contributed to the rise in the price of gas, which was passed on to food prices, to the increase in the price of fertilizers, and to the prices of energy-intensive industrial goods.

These secondary effects on the various markets resulted in inflation reaching 5.9% in the euro area at its last measurement and energy price inflation reaching over 30%.

“We expected that these disturbances would be alleviated by the return of the economy to normal after the pandemic. However, the Russo-Ukrainian war creates significant uncertainty about the economic prospects,” she said.

How much inflation will rise and how much growth will slow down will ultimately depend on how the war develops and the imposition of sanctions. Reflecting this uncertainty, at the last meeting of the Governing Council, ECB experts developed various scenarios to capture some of the possible outcomes. The longer the war lasts, the higher the financial costs will be, and the greater the chance that the worst-case scenarios will materialize, she added.

Cypriot economy

Regarding the Cypriot economy, the head of the ECB stated that this situation holds great challenges for Cyprus as well. The country will be affected by inflationary pressures exerted by higher energy costs due to its dependence on oil imports for energy production.

In the tourism sector, the number of visitors from Russia and Ukraine, which accounted for 27% and 5%, respectively, of total arrivals in 2021 will decrease.

In addition, given the importance of Cyprus as a center of foreign direct investment to and from Russia, professional services, such as accounting, consulting and legal, are also expected to be affected.

On the positive side, the fundamental economic growth of the Cypriot economy has become more robust in recent years. Non-performing loans decreased from about 50% of total loans in 2014 to single digits at the end of last year. Overall, the banking sector has a high level of capital adequacy and liquidity and openings to Russia are limited.

Monetary and fiscal policy

“By taking the right policy measures, we can mitigate the economic consequences of war and manage the high levels of uncertainty we face,” Lagarde said. Fiscal policies have a number of tools, such as tax cuts and grants. At EU level, the rules have begun to be relaxed so that governments can take the necessary measures to protect their citizens.

The additional fiscal measures announced in the euro area after the invasion of Ukraine amount to 0.4% of euro area GDP this year. Similarly, Cyprus is taking measures to reduce energy taxes and diversify tourist flows through new airline programs and programs to support domestic tourism.

European integration

But in the longer term, “we need a European approach, a cross-border cooperation, to adapt to the post-invasion world. The war highlighted the deep strategic vulnerabilities in our security and trade relations, vulnerabilities that we can tackle.” “Only if we are more united. This rightly brings to the fore Europe ‘s goal of achieving’ strategic autonomy ‘.”

The European Commission has already announced some ambitious goals, such as doubling Europe’s share of the global semiconductor market by 20% by 2030. Last week, European leaders agreed to reduce demand for Russian fossil fuels and boost energy. diversifying liquefied natural gas (LNG) reserves and increasing investment in clean energy sources.

The “green” inflation

This is clearly desirable, she said, but will bring some costs to the transition phase. Supply chains will need to be restructured and energy supply reorganized, and the transition to a green economy is likely to increase pressure on some already scarce ores and minerals. Electric cars, for example, use six times more minerals than conventional cars.

“Europe needs a plan to ensure that the necessary investments are made as quickly and smoothly as possible, through a partnership of public and private funding,” added Lagarde.

Next Generation EU – the € 750 billion fund created to support the pandemic recovery – will boost public investment in the coming years. About 40% of the expenditure has been allocated to the transition to a green economy. In Cyprus, the construction of a new terminal for LNG imports has already begun, which is financed mainly by EU grants and loans from the European Investment Bank.

He said, however, that it was necessary to mobilize private funding more vigorously, and to this end we must make better use of Europe’s large stock of private equity. At present, European capital markets are fragmented between different countries instead of representing the whole of Europe. That is why the Capital Markets Union – the task of unifying Europe’s capital markets – is now more important than ever.

On the ECB side, and in the context of the ongoing conflict, the European Central Bank has made it clear that it will take all necessary steps to ensure price stability and safeguard financial stability. In addition, “we have implemented specific policy measures in response to the uncertainty we face today.”

“As I explained last week, the best way monetary policy can handle this uncertainty is to emphasize the principles of choice, gradual change and flexibility,” he said.

First, choice means that “we are ready to react to a number of scenarios, and the course we take will depend on the incoming data.” and after the end of the net asset purchases, these purchases will be completed under the asset purchase program (APP) in the third quarter of this year, but if the medium-term inflation outlook changes and financing conditions cease to be compatible with further progress towards the 2% target, “we are ready to revise the net asset markets timetable in terms of size and duration.

Second, a gradual change means that “we will move carefully and adjust our policy based on the feedback we receive about our actions. and they will be gradual ”.

Thirdly, flexibility means that “we will use all the tools at our disposal to ensure the uniform transmission of our policy throughout the euro area”.