Peter Schiff: ECB Inflation Fight Bad News for the Fed

The European Central Bank (ECB) raised interest rates another 75 basis points last week. In his podcast, Peter Schiff explained how the ECB inflation fight could create big problems for the Federal Reserve and the US dollar.

The 75-basis point rate hike was a huge ECB standards, but it’s still basically spitting into the ocean when it comes to battling eurozone inflation. European inflation is worse than US inflation. The official CPI came in at a record 9.1% in August. This rate hike brings the eurozone interest rate to 1.25%. Given that it was below zero at the beginning of the year, the ECB is taking a pretty aggressive stance. But even with the hiking, the real interest rate is still -7.85%. That’s not going to slay 9.1% inflation.

Euro weakness has contributed to the high eurozone CPI. The euro traded below parity with the dollar for a good part of last week until a small rally after the ECB announcement. Peter said euro weakness is also one of the reasons US inflation isn’t even higher.

While the eurozone has had to deal with the problem of a weak euro making their inflation stronger, America has had the benefit of a strong dollar making our inflation weaker. So, as bad as our inflation has been, think about how much worse it would have been had the dollar been weak as opposed to strong — at least relative to other currencies.”

Peter said he thinks the tone of the ECB press conference was more significant than the rate hike that was bigger than expected. ECB president Christine Lagarde made it clear she is now firmly in the inflation-fighting camp.

Her rhetoric is very similar to Jerome Powell’s rhetoric in how committed the ECB is to fighting inflation and bringing inflation back down to its 2% target.”

This 2% target represents a subtle but significant shift in ECB policy. Under Mario Draghi, the ECB emphasized a policy of getting inflation close to but always below 2%.

Now, of course, that whole policy made no sense, and nobody questioned it. I never heard a single person at a press conference talk about how ridiculous such a policy was and ask Mario Draghi to explain it. After all, why is 1.9% inflation great, but 2% is a disaster, and so is 1.8? What is the magical number that makes 1.9 the sweet spot? Or is it 1.99? Maybe 1.9 is still too low because you can still get closer to 2% without touching it.”

Peter said this “nonsensical” policy was all about trying to come up with an excuse to continue with an easy money policy to protect eurozone politicians from facing reality and cut government spending.

[The ECB] was trying to bail out European politicians by allowing them to deficit spend, to continue to buy votes with borrowed money, and to make it work, the ECB had to keep borrowed money super-cheap. So, they came up with this ridiculous theory that because inflation was still not quite close enough to 2%, they needed negative interest rates. They needed quantitative easing.”

Two percent was originally conceived of as a ceiling. The original idea was to keep inflation below 2%, not get as close to 2% as possible. As Peter pointed out, getting close to 2% makes no sense. Why is 1% inflation a problem? Nevertheless, when eurozone CPI was running at 1.5%, Draghi insisted it wasn’t enough.

Now, the ECB is faced with an even bigger problem. It has to move the inflation needle down from over 9% back down to 2%.

If it was so difficult to get it up to two from just below, imagine how much more difficult it’s going to be to get it all the way back down from nine-and-a-half to two. And what type of political pain are Europeans going to have to endure as a consequence of this?”

We’re about to find out how much pain Europeans are going to have to do because Lagarde is saying the ECB is going to bring it down come hell or high water.

As Peter noted, the most recent rate hike doesn’t do much to bring the ECB closer to that 2% goal. Lagarde even admitted that the current rate remains accommodative.

If inflation is the problem, and you’re committed to solving it, why are you deliberately making it worse? If you know you have a stimulative monetary policy in the face of much too high inflation … why do you continue to fuel the fire? If Lagarde was really serious about fighting inflation, she would have raised interest rates a lot more than 75 basis points.”

Why would you not raise rates to the level you think they need to be if inflation is really the threat that’s being conveyed?

The reason they’re not doing that is because they can’t do that, which is basically an admission that they can’t really fight inflation either. All they can do is pretend that they’re going to fight inflation.”

In fact, they are in a position very similar to the one the Federal Reserve finds itself in.

Peter said Lagarde seems to be sending a message to eurozone politicians that they had better get their house in order because they can no longer count on the central bank to bail them out.

Keep in mind, unlike the Fed, the ECB is a single mandate bank. Its sole function is price stability. With inflation over 9%, it doesn’t have any wiggle room, regardless of the economic or market pain.

Peter said this could be a “game-changer” for the markets. Up until last week, the Fed was the only of the three major central banks pretending to fight inflation. Now, Japan is the only one still churning out easy money. Japanese inflation remains a bit below that of Europe and the US, giving policymakers there a little time before they have to pivot.

The ECB pivot could have a major impact on the dollar, and Peter said he thinks the euro has seen its lows relative to the greenback. Legarde even conceded that the weak euro was contributing to the inflation problem. That would imply policy going forward will be to strengthen the euro.

If the ECB is really committed to a strong euro to fight inflation, that is a big problem for the United States, which is now going to have to deal with a weaker dollar, which is going to complicate its efforts to fight inflation. … The Fed’s efforts to fight inflation were being helped by the strength of the dollar. But, if now the dollar is going to turn, and it’s going to weaken instead of strengthening, that is going to put upward pressure on US inflation at the same time that it puts some downward pressure on eurozone inflation. And now, the Fed is going to have to fight even harder and the markets are not prepared for that outcome at all.”

In this podcast, Peter also talks about Jerome Powell’s admission that the US is on an unsustainable fiscal path, the fact that the Fed is an enemy of the people, how the UK government will make the energy problem worse, and the lack of new money flowing into crypto.