Lagarde urges patience at ECB despite ‘painful’ inflation surge

Christine Lagarde has said the European Central Bank should remain "patient" and avoid tightening policy prematurely, despite soaring euro zone inflation that is "unwelcome and painful", particularly for poorer people.

“At a time when purchasing power is already being squeezed by higher energy and fuel bills, an undue tightening would represent an unwarranted headwind for the recovery,” the ECB president said in a speech to a Frankfurt banking conference.

“We must not rush into a premature tightening when faced with passing or supply-driven inflation shocks,” Ms Lagarde said, signalling that the ECB was likely to maintain a sizeable stimulus at its meeting next month even as other central banks withdraw support.

Ms Lagarde’s remarks knocked the euro, pushing it down 0.7 per cent against the dollar to trade at $1.284, close to a 16-month low. The euro also lost ground against other major currencies including sterling and the yen. Against the Swiss franc it hit a six-year low of 1.048 francs.

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The common currency had already been losing ground over the past week over expectations of a growing interest rate gap between the euro zone and other major economies, as central banks such as the US Federal Reserve and Bank of England respond to the recent surge in inflation with tighter policy.

Euro zone government bonds rallied on the prospect of ECB policy staying accommodative for longer, and were given a further boost by news of fresh German and Austrian restrictions being implemented to contain the spread of Covid-19. The yields on German 10-year government bonds, a benchmark for assets across the euro zone, fell 0.04 of a percentage point to minus 0.32 per cent, the lowest level in two months.

“The market is understandably fearful of further Covid-related disruptions and the impact that could have on growth,” said Lee Hardman, a currency analyst at MUFG. “That certainly helps Lagarde’s efforts to push back on expectations for early ECB rate hikes.”

Root causes

Last month, inflation in the euro zone hit a 13-year high of 4.1 per cent, well above the ECB’s 2 per cent target, prompting some investors to bet that the ECB would raise rates next year. But Ms Lagarde said many of the drivers of higher inflation, such as soaring energy prices and supply chain bottlenecks, were “likely to fade over the medium term”.

“This inflation is unwelcome and painful – and there are naturally concerns about how long it will last,” she added. “We take those concerns very seriously and monitor developments carefully.”

The euro zone economy faced a “mixture of shocks, which is partly related to catch-up demand but has a strong supply-driven element too”, Ms Lagarde said. “Tightening policy prematurely would only make this squeeze on household incomes worse.

“At the same time, it would not address the root causes of inflation, because energy prices are set globally and supply bottlenecks cannot be remedied by the ECB’s monetary policy,” she added.

Most investors expect the ECB to say next month that its flagship €1.85 trillion bond-buying programme, which it launched last year in response to the pandemic, will come to an end in March 2022. However, the central bank is widely expected to step up its longer-standing asset purchase programme at the same time to limit any sell-off in bond markets.

Vital signal

Having committed not to raise rates before it stops primary bond purchases, next month’s decision will provide a vital signal on the potential timing of the first rate rise.

Ms Lagarde indicated the ECB was likely to keep buying bonds for much of next year, saying: “Even after the expected end of the pandemic emergency, it will still be important for monetary policy – including the appropriate calibration of asset purchases – to support the recovery and the sustainable return of inflation to our target of 2 per cent.

“We do not see the conditions – either at the economy-wide level or at the sectoral level – for inflation rates above our target to become self-sustained,” she said. “Monetary policy today must therefore remain patient and persistent, while being alert to any possible destabilising dynamics emerging.” – Copyright The Financial Times Limited 2021