Lagarde Warns Against Overreacting to Transitory Price Shock

(Bloomberg) -- Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.

President Christine Lagarde said the European Central Bank should be wary of withdrawing stimulus too quickly, reasserting her view that inflation isn’t getting out of control in the euro area.

There are “no signs that this increase in inflation is becoming broad-based across the economy,” Lagarde said at an ECB conference Tuesday. “The key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium term.”

While inflation has spiked substantially above the ECB’s goal, Lagarde blamed a rebound in energy prices from 2020 and frictions from supply-chain bottlenecks. In her view, once these pandemic-driven effects pass, “we expect inflation to decline.”

Other central banks are also sticking to the view that the current inflation spike will prove transitory, but Lagarde’s position is particularly dovish. 

Her latest comments set the ECB apart from other major central banks, as both the Federal Reserve and the Bank of England have shifted their tone in response to the inflation.

Anticipation of Fed tapering is already helping to push global bond yields higher, with U.S. Treasury yields at the highest since early 2020. 

No Rush

Highlighting the ECB’s policy guidance, Lagarde said she won’t be rushed into action, and that the ECB will lead the markets, not the other way around. 

“Our forward guidance has already led to a better alignment of rate expectations with our new inflation target,” she said. “We expect to see further progress toward an even tighter alignment between the expected time of lift-off for our policy rates and the most likely inflation outlook as markets continue to absorb the rationale and key purpose of our forward guidance.”

Traders currently expect a 10-basis-point rate hike in the first half of 2023. The euro remained under pressure on Tuesday, trading down 0.2% at around $1.1675, amid broad dollar strength. 

Euro-area inflation accelerated to 3% in August, and may move even higher in the coming months before slowing next year. The ECB sees price growth averaging just 1.5% in 2023.

Higher inflation now is threatening to damp economic momentum if it means companies pass on higher costs and consumers turn hesitant to spend. Europe’s recovery has already lost some steam recently amid supply-chain problems and a slowdown in the services sector following an initial rebound from coronavirus restrictions. 

Policy makers are still confident that growth will continue, allowing them to phase out pandemic stimulus next year. The ECB’s 1.85 trillion-euro ($2.2 trillion) emergency bond-buying program is set to end in March, and officials have set up their December meeting as the moment to decide how to reshape monetary policy to avoid derailing the recovery. 

Lagarde argued that she and her colleagues are committed to preserving favorable financing conditions as long as the pandemic lasts. 

“And once the pandemic emergency comes to an end -- which is drawing closer -- our forward guidance on rates as well as purchases under the asset purchase program will ensure that monetary policy remains supportive of the timely attainment of our medium-term 2% target,” she said.

©2021 Bloomberg L.P.