Lagarde sets ECB apart in central banks’ shift to tighter policy

ECB president promises not to ‘overreact’ to temporary supply shocks driving inflation higher

Christine Lagarde has distanced the European Central Bank (ECB) from the move towards tighter monetary policy by many other central banks, promising not to “overreact to [the] transitory supply shocks” driving inflation higher.

The ECB president said policies to shift countries towards a low-carbon economy could fuel further price pressures, as shown by the recent surge in gas prices. However, she said that in the euro zone there were still “no signs that this increase in inflation is becoming broad-based”.

“The key challenge is to ensure that we do not overreact to transitory supply shocks that have no bearing on the medium term,” Ms Lagarde said.

Other western central banks, including the US Federal Reserve and the Bank of England, have recently signalled a move towards tighter monetary policy in response to a recent surge in inflation. Norway’s central bank last week raised interest rates, alongside similar moves in Pakistan, Hungary, Paraguay and Brazil.


However, Ms Lagarde sent a different message in her opening address at the ECB’s annual forum on central banking.

“Monetary policy must remain focused on steering the economy safely out of the pandemic emergency, and lifting inflation sustainably towards our 2 per cent target,” she said.

Ms Lagarde added that the ECB would “continue to provide the conditions necessary to fuel the recovery”.

Krishna Guha, vice-chair of Evercore ISI, a consultancy, said Ms Lagarde’s speech “appears intended to push back against the idea that the ECB will be dragged along by a global turn in the tide as the Fed shifts moderately hawkish and the Bank of England turns sharply hawkish”.

Inflation in the euro zone rose to a decade high of 3 per cent in August, well above the ECB’s target of 2 per cent. Economists say it could rise as high as 4 per cent by November, driven by higher energy prices, supply chain bottlenecks and resurgent demand – although they expect inflation to fade next year.

Ms Lagarde said much of the recent acceleration in inflation was due to “base effects” caused by a comparison with last year’s ultra-low inflation levels.

“Once these pandemic-driven effects pass, we expect inflation to decline,” she said.

“Monetary policy should normally ‘look through’ temporary supply-driven inflation so long as inflation expectations remain anchored.”

Wholesale gas prices have more than quadrupled in Europe this year, contributing to a sharp increase in wholesale electricity prices and disrupting sectors that rely on gas by-products, such as fertiliser-makers and food packaging.

Green policies

Ms Lagarde cited a forecast by the Network for Greening the Financial System, a club of financial supervisors and watchdogs, that green policies could increase inflation by 1 percentage point over time.

But she added that if carbon tax revenues were not used to mitigate the impact of higher energy prices on households it “might reduce purchasing power and lead to relative price changes that push down underlying inflation”.

This month the ECB slowed the pace of its bond-purchases in response to lower financing costs, but government bond yields have since risen in anticipation of monetary tightening.

Investors are waiting for the ECB to announce in December its plans for ending its €1.85 trillion bond-buying programme and to publish inflation forecasts for 2024. – Copyright The Financial Times Limited 2021