The European Central Bank (ECB), the Bank of England (BoE) and the Federal Reserve (Fed) went on to increase interest rates one after the other, as it was expected. Three central banks, who prioritize the “fight against inflation”, aim to make borrowing difficult and cool the economy by hiking the policy interest rate. While the ECB raised the policy interest rate to 2%, the Fed increased it to 4% and BoE to 3%.

ECB President Christine Lagarde asserted there is still way to go on interest rates, and that with the increase, their goal is to reduce inflation to 2%. Inflation in the euro area is expected to rise from 9.9% in September to 10.7% in October. Decisions on interest rate that make borrowing difficult are thought to pose a risk of global recession.

However, the debate that the ECB’s reasons for raising interest rates are not the same as those of the Fed is also on the agenda. Some economists argue that for the U.S., post Covid-19 period led to the rapidly increasing demand and therefore inflation, while in the euro area, geopolitical tensions (such as the Ukraine-Russia war) have become the source of inflation. This view is of “inflation-phobic” Bundesbank origin, fearing that inflation will become permanent in the euro area and that this will strain the German and European economies, especially in the year-end collective labor agreement negotiations in Germany.

On the other hand, we should also note that in the euro area, which is said to have fallen into an inflation pit due to geopolitical reasons, the hike in energy prices, which experienced a huge increase in summer, has started to decline. Natural gas prices fell by 50% compared to September and by 70% compared to August, when it peaked. The EU has clearly stopped seeing this nightmare of winter freeze, for a while. In this case, the view that geopolitical elements trigger inflation is partly impractical.

Source of inflation: Demand or profit?

But what is not right for Europe is right for the United States? Earlier, we stated the mainstream interpretation of the origin of inflation in the United States was excessive demand. There are also variants of this statement: Excessive money supply causes inflation; the fact that demands for wage increase force companies to increase prices causes inflation…

These statements are highly controversial, and the policies of the central banks are contradictory. For example, BoE, which claimed to control inflation by increasing interest rates, launched an emergency bond purchase program after the real estate market alarmed following Liz Truss’s package of tax cut, and did not hesitate to release money.

Moreover, these statements observed to lose their reputation within the mainstream. In an article published in the Financial Times, it was argued that the Fed’s showing excessive demand and wages as the cause of inflation did not reflect the facts. The article by Paul Donovan, the chief economist of the world’s largest asset manager, UBS, identifies the source of inflation as the profit margins of companies, with a long-lost openness.

Prices are rising faster than wages, and real wage growth is negative, Donovan says. This finding is based on the following: Businesses and companies have grown their profits by reflecting price increase to their customers, while at the same time making people work harder and increasing wages less than the prices. Post-pandemic household continued to consume by saving less and borrowing more, and thus managed to make up for the sorry state of real wages.

Numerical repercussions of sanctions to the German industry

A report released by the IMF last February estimated that 60% of inflation in the euro area was caused by supply shocks. Therefore, supply chains smashed by COVID-19, the destruction in international trade and the manufacturing industry are among the main causes of inflation. It is seen that the sanctions imposed on Russia have also stirred up trouble in the manufacturing industry in Europe, especially in the German industry.

Perhaps BASF, the world’s largest chemical producer, best describes the state of the German industry shaped after the sanctions against Russia. BASF reported last month that should Germany be forced to ration gas this winter, it may shutter its flagship plant, which employs 39,000 people. Even if this does not happen, BASF will have to stop some of its operations next year, and European consumers will be constrained to U.S. and Asian suppliers for their chemical supply, according to experts. It should be kept in mind that natural gas is not only an energy source for BASF, but also serves as a raw material for making products such as ammonia. Therefore, BASF CEO Martin Brudermüller is one of the most important opponents of sanctions against Russia.

According to preliminary estimates published in mid-October, BASF’s net income in the first three quarters of 2022 was 909m euros. That’s a 32% drop from the same period last year. The company’s second quarterly report also shows that energy costs rose by 260% compared to the same period last year, costing the company 500m euros.

It should also be noted that along with BASF, Putin supporter Russian oligarch Mikhail Fridman is the co-owner of oil and gas manufacturer Wintershall Dea. Wintershall Dea was also a major financial investor of in the Nord Stream 2 gas project.

The German energy giant Uniper is of a similar case. Announcing the balance sheet for the first nine months of 2022, Uniper reported a record loss of 40 billion euros. In September, the German government nationalized Uniper by acquiring a 99% stake. The government is expected to give Uniper a 30-billion-euro support package.

Reaction grows against US-Germany-based economy in Europe

Contrary to all expectations, Germany managed to grow by 0.3% in the third quarter. But alarm bells are ringing for other EU countries.

The EU’s second largest economy, France, grew by 0.2% in the third quarter. The growth in the second quarter was 0.5%; the recession was driven by a decline in consumption due to high inflation. Similarly, Spain grew by 0.2% in the third quarter, despite a 1.5% growth in the second quarter and a large increase in tourism revenues in post Covid-19. Yet again the slowdown in growth is also caused by decline in consumption due to inflation.

As a matter of fact, reactions to the ECB’s hike in interest rates were immediate. In her maiden speech, Italy’s new prime minister, Giorgia Meloni, sniped at ECB, saying hike in interest rates would create additional difficulties for states, like Italy, which have high public debt. Italy’s public debt is currently around 150% of Gross Domestic Product (GDP).

French President Emmanuel Macron, whose country’s public debt to GDP ratio is around 113%, has also been critical of the ECB’s decision. Unlike the United States, European economies are “not overheating”, Macron told experts that demand must be curtailed to reduce inflation. Finnish Prime Minister Sanna Marin said last month that the ECB’s credibility has become questionable, since it is driving economies into recession.

In Germany, on the other hand, the voice of the opposition began to grow more. Tino Chrupalla of the Alternative for Germany (AfD) party urged the German parliament to lift the sanctions against Russia, stop selling weapons to Ukraine and withdraw Germany from U.S. unilateral politics. Sahra Wagenknecht of the Left Party described the Greens as the ‘most dangerous party’ in the Bundestag for destroying the German economy with their stance on the Ukrainian war. Meanwhile, after the Left Party Group chairman separated himself from Wagenknecht, saying that the most dangerous party was still the AfD, rumors increased that the opposition figure would leave the party and form a separate organization.

German Chancellor Olaf Scholz took several CEOs on a trip to Beijing. According to CNN, Scholz is accompanied by German industry titans such as Volkswagen, Siemens, Deutsche Bank and BASF. The chancellor’s visit to China comes amid controversy that began when the Chinese state-owned Cosco sought to buy shares in the operator of one of the four terminals at the port of Hamburg. It should also be acknowledged that China is Germany’s biggest trading partner. Germany, whose economy is based on exports and is separated from the Russian market, appear to be not wanting to lose the Chinese market.