Lagarde’s Cautious Optimism Was Too Optimistic

(Bloomberg Opinion) -- Christine Lagarde sounded mildly optimistic as she talked about the euro region’s economy last week. Friday’s disappointing data gives her a reality check. The situation remains fragile and the European Central Bank is still far from its inflation target. The newly installed ECB president would be wise to return to her earlier caution.

The monetary union expanded by a mere 0.1% quarter-on-quarter at the end of last year, which was slightly below estimates. The currency area only grew at a yearly rate of 1% in 2019, the slowest rate since 2013. France and Italy both shrunk in the fourth quarter, by 0.1% and 0.3% respectively. While Paris can blame one-off factors, including a wave of strikes, Rome really has no such excuse.

Even worse for the ECB, inflation showed signs of abating. Prices grew by 1.4% in January, compared to a year earlier. Core inflation — stripping the headline measure of volatile items such as energy — disappointed, only hitting 1.1%. This is well below the ECB’s target of keeping inflation close to, but below 2%.

This gloom is, in a sense, hardly surprising. Policy makers had repeatedly warned of the risks facing the euro-zone economy, as the trade war between the U.S. and China hit exports and confidence across the world. The two countries have reached a truce, which should help to lift spirits. A range of confidence indicators have proved more positive since the start of the year, while unemployment has also continued to fall.

This helps to explain why Lagarde has sounded moderately optimistic since her press conference last week. Last Thursday, the ECB president said there was “some stabilization in euro-area growth dynamics” adding that some of the uncertainties surrounding global trade had receded. She also noted some signs of a moderate increase in underlying inflation. A day later, in an interview with Bloomberg Television, she went a step further, warning markets that ECB policy was not on autopilot.

In the cautious world of central banking, this shift in language is hardly trivial. Mario Draghi, Lagarde’s predecessor, had gone out of his way to insist that the ECB would remain “patient, prudent and persistent” in its efforts to lift inflation. He also sought to convince markets of the credibility of the ECB’s pledge to keep rates at their current ultra-low level for an extended period of time. This steady forward guidance was, in a sense, a form of autopilot.

Lagarde’s shift was heavily caveated. In particular, she wanted to warn investors that policymakers will not sit on their hands as they discuss the first overhaul of the ECB’s monetary policy strategy in nearly two decades. However, combined with her slight optimism on the growth and inflation outlook, there was enough to detect a hawkish tilt in the central bank’s communication. Those in Germany and elsewhere who have made the case for tighter money in the euro area had finally something to be pleased about.

This week’s data are a useful reminder that the economy of the countries in the monetary union remains weak. Add to that the risk that the “coronavirus” saps substantial demand out of China, while also disrupting global supply chains, and you can see that the future looks uncertain. Governments should do their part, of course: Some, such as Germany, should loosen their fiscal belts. Others, including Italy, should redouble their efforts at attracting investment. But, given the lack of a single budget, the ECB remains central to supporting the economy. The euro region is still far from the point where it can do without its central bank’s support.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

©2020 Bloomberg L.P.

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