ECB rate dilemma: Underlying inflation vs perceived costs

The ECB's hard line: How high can interest rates go?

The cheapest tomatoes in the greengrocer cost €3.50 per kilo. This is not a rhetorical figure; it is the price anyone finds this week, summarizing the cost of living crisis better than a hundred reports. With that shopping basket, the issue of ECB interest rates stops being an analyst's game and becomes a matter of household survival. The debate is no longer about whether the central bank will raise rates, but how much it is willing to tighten before something breaks. Aggressive scenarios cite figures ranging from 2.5% to 7%: the difference between a scare and a textbook recession.

Calculations placing rates between 3.5% and 4.5%

The Taylor rule, a formula central banks have used for decades to stay on track, yields an uncomfortable range. Assuming underlying inflation of 2.5%—and accepting that data point, which is a big assumption—rates should move between 3.5% and 4.5%. Translated: staying at 2.5% is not prudence; it is only half the journey. For critical analysts, stopping there suggests a desire to keep inflating the bubble of expansive public spending.

The fundamental disagreement is not technical, but diagnostic. Here appears the mismatched data: perceived inflation, the amount paid without question at the supermarket checkout, sits around 7%. Official statistics and consumers' wallets have been living on different planets for months. A full breakdown of that range, scenario by scenario, leaves a margin much wider than typical headlines suggest.

Raising money prices doesn't fix cost-push inflation

Raising rates works when inflation stems from excess demand: too much money chasing few goods, making credit expensive cools buying enthusiasm. That does not seem to be the current scenario. Consumption falls and real purchasing power bleeds away, with taxes, energy, bureaucracy, and stagnant wages as the usual suspects.

If the diagnosis is correct, tightening monetary policy won't lower prices: it will drown companies already operating on the brink. The prescription proposed by this school of thought is the opposite of the central bank's: less state, less bureaucracy, and room to return to manufacturing. Easier to write than to execute.

Germany fades and debt returns to the spotlight

Across the Rhine, the crisis is no longer a hypothesis. The AfD has openly acknowledged Germany's difficulties, while Merz tries to pull the country out of stagnation, blaming external problems as the main cause. Europe's locomotive has long run out of coal.

With industry stalled, debt returns to the center of the debate. High rates don't bother those who spend what they earn; they crush those refinancing uncontrolled deficits for years. The list of suspects is known: France, Italy, and Spain. And here comes the uncomfortable question: Can the euro withstand tight monetary policy with four major economies on the wire?

European industry: The data breaking the narrative

Industrial production as a percentage of GDP reveals a picture few expected. In 2024:

• Spain: 15.9%
• Belgium: 15.1%
• United Kingdom: 12.5%

And in industrial value added over GDP, Spain surpasses Belgium, the Netherlands, and France. The problem is long-term: since the 1970s, productivity and real wages diverged and never reunited. Those attributing the origin of this gap to the GATT rounds of 1994 and 1995 argue that the West stopped manufacturing to focus solely on creating money.

They insist that agriculture, industry, and energy are the foundation. Without them, any country dependent on foreign production is at the mercy of whoever moves a piece first. Calculating that dependency, with the 2024 international comparison on the table, turns the debate into more than rhetoric.

Before the euro existed, the peseta coexisted with interest rates reaching 14% and inflation no better than today's. When asking how far the ECB is willing to go, it is worth remembering where we came from.