With the announced reduction in the funds earmarked for debt purchases and a rise in interest rates on the horizon, the European Central Bank is putting the recovery of the most indebted countries at risk. They may be the collateral victims of the war on inflation.

Growth or price stability? This is the dilemma facing the European Central Bank (ECB) through its policy of buying debt and interest rates. And the bet today is clear: its president, Christine Lagarde, wants to avoid runaway inflation at all costs despite the economic uncertainty caused by the war in Ukraine.

The ECB’s forecast is that price rises in the European Union will reach 5.1% on average this year, almost two points higher than they predicted in December. This is why Lagarde recently announced a tightening of monetary policy to contain inflation: the ECB’s monthly debt purchases will fall from 40 billion euros in April to 30 billion in May and 20 billion from June onwards.

Bond purchases during the pandemic

Until now, the ECB has been purchasing around 80 billion euros of debt per month, three-quarters of it under a special programme set up to deal with the Covid-19 crisis.

The ECB is even considering ending net debt purchases if the measures are not sufficient to curb inflation. It should be borne in mind that during the pandemic, the ECB has bought nearly two trillion euros in debt. From January 2020 to mid-2021, the eurozone’s debt stock went from 86% to 100% of GDP.

Rising interest rates

In addition, the ECB announced that there will be a “gradual” rate hike after some time. Analysts estimate that this policy shift could begin in the latter part of this year or early 2023. However, inflation developments will dictate the timing and intensity.

These decisions will particularly affect the Spanish, Italian, Portuguese, and Greek economies, as the ECB is buying a large part of the debt issued by these countries. Debt in Spain is already 125% of GDP, in Portugal 140%, in Italy 160%, and in Greece 210%.

In the case of Spain, the net borrowing requirement for 2022 is estimated at around 75 billion euros. The economic uncertainty and the energy crisis caused by the war in Ukraine are now added to the convalescence of the pandemic in their economies.

Less room to maneuver for the most heavily indebted

The ECB’s announcement to reduce debt purchases will considerably reduce the capacity of the most indebted countries, including Spain, to finance fiscal policy measures to stimulate recovery, either through subsidies or a reduction in the tax burden on individuals or companies. Another undesired consequence could be that the risk premiums on the debt of these countries could start to rise.

All of this is taking place in an environment of great uncertainty due to the international situation and the evolution of energy prices, which have a direct impact on the price of most products.

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