Axel Weber experienced the Great Recession of 2008 very well as head of the Bundesbank. And although he believes that the current crisis is not the same, it has “some similarities” to the dark period of history. Weber, who led the most orthodox sector of the European Central Bank until 2011, believes that the monetary authorities took too long to respond to inflation. At least a year and a half. That caused a sudden increase in interest rates that exposed the weaknesses of banking, especially in the United States. “What we see are the first signs of weakness. And I think they should be taken seriously, more than what has been done,” said Weber, who in a media meeting in Madrid this Thursday recalled that the big impact of the increase is yet to come. “It usually takes two or three years,” he said.
Weber, now an adviser to investment manager Flossbach von Storch, previously led all the pools to succeed Jean-Claude Trichet as head of the ECB. However, Weber left the race for personal reasons and went into the private sector at UBS bank in Switzerland. As the head of the hawks, the German had several clashes with Trichet over debt buyout programs. The one president of the Bundesbank between 2004 and 2011 considered that behind the inflationary crisis – which reached double digits last year – was the “huge” fiscal and monetary stimuli launched during the pandemic. Central banks, in his opinion, did not see this and took at least 18 months to raise interest rates.
The Federal Reserve finally made its move in spring 2022, while the ECB did it in the summer. “We have seen the fastest cycle of monetary policy tightening in decades. The largest in the history of the Eurosystem, but also in the United States since the 70s,” he recalled. In the past, Washington raised the price of the currency, by 1% due to the dotcom crisis, up to 5.25% between 2003 and 2006. After the tightening, came the Great Recession. And although the two crises are not comparable, Weber believes that all the embarrassments discovered so far should not be forgotten or buried, in particular, the weakness of medium-sized banks in the United States. Not surprisingly, the effects of monetary policy are not immediate and chaos may return. “The greatest impact of the increase in interest on corporate profit margins, on credit conditions, on financing, on real estate investments, on the purchase of houses or taking out a mortgage… All this requires between in two and three years,” he stressed.
Weber believes that central banks have done most of their work, although he doubts that the United States will get to the “last mile” of the 2% inflation goal through the “soft landing” that the president of Federal Reserve, Jerome Powell. “The comparison to an airplane is not appropriate,” warns Weber. Especially, he said, if they go through it on autopilot. For Germany, the cooling of the economy is likely to lead to a recession. And he warned investors not to be too quick to make assumptions about when central banks will start lowering interest rates.
Structural reforms
Markets are so far discounting that the price of the currency will start getting cheaper next year. And they believe that the central banks of the United States and Europe will not return to ultra-low rates, but to the middle ground between 2% and 2.5%. Weber warns against such a belief. The former president of the Bundesbank agreed that the bullish cycle is coming to an end, although he has not yet ruled out a December hike. However, he urges caution when looking ahead. “The central banks told us that they will keep the high rates for a while, because if they continue at the current level for a long time we can end the inflation,” explained the German. Weber believes that, in this context, it is not a good idea to enter the debate now on whether the central banks’ inflation target should be raised from 2% to 3%. This debate, which at the moment he believes is limited to the academic field of the United States, in his opinion means facing a blow to his credibility.
The dilemma of when to lower the price of the currency will occur at some point due to the high deficits and debts left by the pandemic and the energy crisis. However, Weber concluded that the debate in the coming years will not be about monetary policy. In his opinion, the crux is in the pending structural reforms in the labor market, pensions, the social fabric and unity. And finally, on the borders of Europe towards the countries of the East, where Brussels decided to provide a “vision” for their integration, including Ukraine. “The big debates in Europe are not on the central bank,” he stressed.
