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Global Economy

ECB director thinks inflation is underestimated

The pressure on Europe's central bank chief Christine Lagarde to raise interest rates quickly is growing. Criticism of the hesitant attitude of the President of the European Central Bank is even coming from within her own ranks. ECB Director Isabel Schnabel has warned that the monetary watchdogs could be too late with the turnaround in interest rates.

The real estate boom increases the risk, said the German economist in an interview with the "Financial Times". When assessing inflation, the ECB must also take rising home prices into account.

A sensitive issue for monetary authorities

Schnabel is addressing a sensitive issue. The ECB has been fermenting for a long time regarding the correct calculation of the inflation rate. As early as the summer, the central bankers are said to have agreed at a closed conference that rising residential property prices should be taken more into account.

Nothing has changed since then. The inflation rate is currently more in the focus of public interest than almost any other economic factor. At the same time, it is central to the future monetary policy of the central banks.

Rents are taken into account, residential real estate prices are not

Hitherto, tenants and homeowners have been treated extremely unequally by EU statisticians. While rents are taken into account when calculating the inflation rate, prices for owner-occupied housing are left out. There is no place for them in the shopping cart of the European statistical office Eurostat – in contrast to other currency areas such as the USA, where house prices are a natural part of the calculation of the inflation rate.

Experts such as Jörg Krämer, chief economist at Commerzbank, have therefore long been in favor of including the rising real estate prices in the euro zone in the calculation of the inflation rate.

Inflation rate would be significantly higher

In fact, the inclusion of owner-occupied housing would push the inflation rate in the euro zone up significantly – especially if you look at core inflation, i.e. excluding the rise in prices for food and energy, which fluctuate sharply. In the second and third quarters of 2021, the inflation rate would have been 0.4 to 0.6 percentage points higher in this case, as the ECB announced today.

A look at asset price inflation also provides a strong indication that consumer prices in their current calculation method greatly underestimate actual inflation. The prices of houses, stocks, gold and parts of businesses – as an alternative measure of inflation – had risen significantly more than consumer prices in 2021.

Asset price inflation is picking up speed

"For 2021, asset price inflation in Germany will be very high at 9.2 percent," emphasizes Philipp Immenkötter, analyst at Flossbach von Storch Research Institute, based on a recent study. By way of comparison: consumer prices in the Federal Republic increased by just 3.1 percent last year.

The price rally on the real estate market, which continued in the second year of the pandemic, had a significant influence on asset price inflation: In 2021, the prices for real estate assets owned by private German households rose by 10.0 percent. Residential real estate prices rose particularly sharply.

Ten years of price rally on the real estate market

The experts at Commerzbank come to a similar conclusion in a recent study. They expect residential real estate to have risen by an average of 10.5 percent in 2021. "House prices are going through the roof," said Commerzbank economist Marco Wagner.

The current boom is by far the longest since statistics began. "While the price increases of the 1970s and early 1990s each came to an end after around eight years, the current price rally has now been going on for ten years," says Wagner.

Danger of a wage-price spiral?

Admittedly, ECB Director Schnabel is by no means alone in her warning that the European Central Bank could be too late with the turnaround in interest rates. The President of the German Savings Banks and Giro Association (DSGV), Helmut Schleweis, recently warned: "There will be considerable economic consequences if the ECB reacts too late or not at all." The euro zone threatens to slip into a dangerous wage-price spiral.

At its last meeting in early February, the ECB left interest rates at zero percent. However, while Lagarde had emphasized in December that an increase in the key interest rate in 2022 was "very unlikely", the top European currency watchdog has now avoided making such a clear statement again. Economists took this as an indication that the ECB could herald the turnaround in interest rates this year.

Many experts are of the opinion that such a first rate hike should come as early as possible. The accusation is that the ECB is lagging behind the actual inflation trend. Should the monetary watchdogs around Lagarde fail to provide specific information on the turnaround in interest rates at the March meeting of the ECB Council, they would continue to give up the reins of action.

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