Christine Lagarde has rejected calls for the European Central Bank to raise interest rates more quickly than planned in response to record inflation, saying it had “every reason not to act as quickly or as ruthlessly” as the US Federal Reserve.
The ECB president warned that raising interest rates too soon risked “putting the brakes on growth” and she told France Inter radio on Thursday that she wanted its monetary policy to act as “a shock absorber” instead. Soaring energy and food prices lifted inflation in the eurozone to a record high of 5 per cent in December, well above the ECB’s 2 per cent target, prompting calls for a faster withdrawal of its generous stimulus policies. Lagarde, however, forecast that inflation in the bloc would stabilise and “gradually fall” over the course of this year, referring to the ECB’s forecasts in December when it said inflation would drop below its target by the end of 2022. “It will fall less than we all had all envisaged a year ago, including all the world’s economists, but it will fall,” she said.
The Fed and the Bank of England are expected to raise interest rates several times this year after stopping their asset purchases. But the ECB in December said it was “very unlikely” to raise rates this year and outlined plans to continue buying large amounts of bonds for most of 2022. “The cycle of economic recovery in the US is ahead of that in Europe,” Lagarde said. “So we have every reason not to act as quickly or as ruthlessly as one might imagine with the Fed.”
Behind Lagarde’s confident stance there are growing divisions within the ECB’s governing council, which came to the fore at its last rate-setting meeting in December over the key questions of how fast price pressures would fade and whether it should withdraw its stimulus more quickly. While council members agreed that “substantial monetary support was still needed” for inflation to stabilise at its target in the next three years, some of them warned that a “higher for longer” inflation scenario “could not be ruled out”, according to minutes of the meeting published on Thursday. “Some members retained reservations about some elements of the proposed package such that they could not support the overall package,” the ECB said. These reservations included criticism of its decision to increase the pace of a longstanding asset purchase programme from €20bn a month to €40bn a month to partly offset the ending of new purchases under its €1.85tn pandemic emergency purchase programme (PEPP) in March.
The dissenters, including the heads of the German, Belgian and Austrian central banks, also objected to extending the period for reinvesting the proceeds of maturing bonds under PEPP by a year until at least the end of 2024. Nevertheless, there was general agreement that given high uncertainty over future inflation the ECB should “retain the ability to calibrate and recalibrate the monetary policy stance in a data-driven manner in either direction”. Despite Lagarde’s confidence that inflationary pressures will fade soon, investors are betting that prices will continue to overshoot the ECB’s forecasts and force it to change its policy stance more aggressively than planned this year.
Markets are now pricing in two 0.1 percentage point interest rate rises from the ECB by the end of the year, despite the central bank’s insistence that higher borrowing costs in 2022 are not consistent with its guidance. After Germany’s 10-year bond yield — which acts as a benchmark for borrowing costs in the euro area — turned positive on Wednesday for the first time since 2019, Lagarde said rising yields meant “the fundamentals of the economy are recovering”.
Critics argue the ECB is being too slow to remove its monetary stimulus because of fears this will push up borrowing costs for governments that borrowed significantly during the coronavirus pandemic. Three German economists — Jürgen Stark, Thomas Mayer and Gunther Schnabl — wrote in a Project Syndicate article this week: “It is becoming increasingly clear that inflation will gain momentum without monetary policy countermeasures”. But they added: “Such tightening would create serious problems for highly indebted eurozone members.”
Source: The Financial Times
