The ECB’s dilemma: is the fight against inflation worth a political crisis?

However, rate hikes might not begin that early. Indeed, during the press conference, Lagarde referred several times to sequencing: the ECB will not hike interest rates before ending purchases under the APP program. Although the central bank confirmed that the APP program will run until the end of the year, there is growing speculation that the new set of ECB's forecasts due in March will come close to fulfilling conditions. That would allow the central bank to stop bond purchases early, thus beginning with interest rates hikes in 2022. Although it is possible for this to happen, the periphery could create some issues that might hinder the central bank's ability to follow this path.

Lagarde said yesterday that sovereign spreads are not a problem because they remain stable. Yet, the BTPS-Bund spread spiked and broke above 150bps for the first time since September 2020. It is a sign that the more aggressive the ECB will be, the wider the BTPS-bund spread will get, entering dangerous territory when it approaches 200bps.

Since the end of the European sovereign crisis in 2013, the BTPS-Bund spread widened above 200bps and sustained above this level only twice: during the 2018 election and the Covid pandemic. The problem with wide sovereign spreads is that financing conditions are deteriorating faster in certain countries of the euro bloc versus Germany. It won't get unnoticed by politicians and could renew political tensions in the euro area.

In that case, will the ECB continue the fight against inflation, or would it stall its tightening agenda to save the euro area from another economic and political crisis?