Can the ECB Tame Inflation?

Welcome to today’s Morning Brief, looking at the European Central Bank’s new interest rate hike, Mario Draghi’s resignation in Italy, Russia’s Ukraine aims, and the U.S.-Canada-Mexico energy dispute.

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European Central Bank (ECB) chief Christine Lagarde is set to announce the bank’s first interest rate increase in 11 years today as Europe seeks to tame rapid price inflation.

The increase, estimated at between 0.25 and 0.5 percent, would still make ECB lending rates among the lowest in the world and would keep the European Union behind recent hikes by the U.S. Federal Reserve. But coming at a time when the eurozone’s economic outlook is uncertain, the ECB intervention risks slowing already sluggish growth and triggering a recession.

The ECB has waited this long to raise rates because, unlike in the United States, Europe’s central bankers are afraid not of a wage-price spiral—where prices increase to match rising wages—but of the spillover effects of the ever-increasing cost of energy, especially gas, driven by the war in Ukraine. Energy costs increased by 42 percent in June, compared with the same month last year, according to the EU statistics agency Eurostat, contributing to a June EU inflation figure of 8.6 percent.

As Foreign Policy’s Christina Lu wrote this month, the combination of high fuel prices and the threat of a gas shutoff from Russia has European policymakers considering a nightmare energy scenario this winter.

So, what can a central bank do about fuel prices? Not much, said Jacob F. Kirkegaard, a senior fellow at the Peterson Institute for International Economics, but it’s going to try anyway.

“All they have is a big sledgehammer. And you don’t necessarily want to sink the economy in order to try to get energy prices down. Because even if the European economy goes into a deep recession, maybe Vladimir Putin doesn’t increase energy supplies over the winter, and prices don’t come down. So, the ECB is really in a corner because of the sources of inflation not being something that they can really affect,” Kirkegaard told Foreign Policy.

As well as trying to preventing a blocwide recession, EU leaders must also account for the differing economic performances of member states. An increase in borrowing costs isn’t as damaging for Germany in the same way it might be for Italy, whose debt-to-GDP ratio of 150 percent is second only to Greece among eurozone countries.

Keeping eurozone countries from suffering different effects of the rate rise, a process known as fragmentation, will be one of Lagarde’s key challenges both today and later in the year, when new increases are expected. Lagarde is set to unveil an anti-fragmentation program to help calm markets, although the details are still under wraps.

And while rate hikes by the Fed are creating ripple effects throughout the global financial system, the wider impact of the ECB decision is likely to be much smaller by comparison, since relatively few countries hold euro-denominated debt.

Erdogan’s Syria incursion. Turkish President Recep Tayyip Erdogan said his plans for a military offensive in northern Syria remain on the table in comments carried by Turkish media following his summit with Russian President Vladimir Putin and Iranian President Ebrahim Raisi this week. Erdogan also criticized U.S. support for the Kurdish People’s Protection Units (known as the YPG), which Washington relies on in its anti-Islamic State operations.

“America has to leave east of the Euphrates now. This is an outcome that came out of the Astana process,” Erdogan told reporters. “Turkey expects this as well because it is America that feeds the terrorist groups there.”

Russia’s aims. Russian Foreign Minister Sergey Lavrov gave a rare insight into Russia’s overall plans for Ukraine in comments to state media on Wednesday. Lavrov said peace talks were currently impossible but blamed the West rather than Ukraine for avoiding negotiations. Lavrov said Russian goals for territorial control had shifted since March from beyond the Donbas to include Kherson and Zaporizhzhia regions “and a number of other territories.” Lavrov added that “geographical tasks” will extend further into Ukrainian territory as long as Western nations continue to supply long-range weapons.

The U.S.-Canada-Mexico standoff. The United States and Canada have requested talks with Mexico to resolve a dispute over the latter’s plans to further nationalize its energy market, which the northern nations say would breach the terms of the United States-Mexico-Canada Agreement. Mexican President Andrés Manuel López Obrador ridiculed the challenge to his energy policy at a press conference on Wednesday, saying that “nothing will happen.”

FP columnist Lynne O’Donnell returned to Afghanistan this week, almost a year after its fall to the Taliban. From there, things went downhill quickly. As O’Donnell recounts in her latest column, she endured “three days of cat-and-mouse with Taliban intelligence agents, who detained, abused, and threatened me and forced me to issue a barely literate retraction of reports they said had broken their laws and offended Afghan culture.” She has now safely left the country.

Read O’Donnell’s account here, and then catch up on the reporting the Taliban would rather you didn’t see.