More fiscal policy than monetary to control inflation

The conflict in Ukraine is a severe short-term adverse impact, but it also marks the end of the long-term trend. Until now, the financial markets have been relatively benign in their assessment of the war's impact. Stocks rose, recovering the losses of the first days. This assessment is based on the following hypothesis: (1) absence of gas/energy rationing; (2) some peace agreement will be reached relatively soon; and (3) there are political options to cushion the European economy (new issue of Eurobonds, for example).

In addition, the markets are reducing the probability of a scenario of aggressive hardening of the central banks, although some type of normalization is still being ruled out. Finally, there is also less reaction to the news about the war.

Once the conflict has ended, the world will be different. This will be accompanied by drastic changes in relative prices, greater pressure on public finances, among other structural changes. In this context, we must ask what normalization of the monetary policy means. The movement observed in the German short-term yield, which rose 70 basis points in 2 weeks, has nothing to do with the gradualism or normalization that is now part of the dominant narrative to date. In the last meeting in March, we detected problems with the communication of the ECB. It focused on the consequences of inflation and said nothing about economic growth. Communication frequently moves in one direction and, later, the institution's officers try to walk it back. There will be a certain normalization of the monetary policy, but in a more expansive fiscal policy context, because there will be a much greater demand for public assets.

It is difficult to design a hardening in a phase with permanent adverse supply impacts. The rates will rise, but the fiscal policy is the main thing to react to these negative supply impacts, which will put some pressure on inflation. The EU most urgently adopt collective decisions in this regard, as achieving a well-done fiscal policy would help the monetary policy.

Although the fiscal capacity is different in the EU member States, the key point is the distinction between bad and good debt; public money must be used prudently. It is essential not to act too aggressively on rates, and the ECB could tolerate higher inflation for a time, until the inflationary expectations begin to relax. Few supported the view that this had begun.

Gonzalo de Cadenas-Santiago, director of macroeconomic and financial analysis at MAPFRE Economics