Tue. Oct 19th, 2021

Christine Lagarde has distanced the European Central Bank from the move towards stricter monetary policy by many other central banks, promising not to “overreact to [the] temporary supply shocks ”which cause inflation to rise higher.

The ECB president said policies to shift countries to a low-carbon economy could put further price pressure, as evidenced by the recent rise in gas prices. But she said there were still “no signs in the eurozone that this increase in inflation was coming on a broad basis”.

“The most important challenge is to ensure that we do not overreact to transitional stock shocks that have no impact in the medium term,” Lagarde said.

Other Western central banks, including the US Federal Reserve and the Bank of England, have recently made progress stricter monetary policy in response to a recent rise in inflation. Norway’s central bank raised interest rates last week, along with similar movements in Pakistan, Hungary, Paraguay and Brazil.

Lagarde, however, sent another message in her opening address at the ECB’s annual forum on central banking.

“Monetary policy must remain focused on sending the economy safely out of pandemic distress and sustainably lifting inflation towards our 2 percent target,” she said. Lagarde added that the ECB “will continue to provide the necessary conditions to stimulate recovery”.

Krishna Guha, vice-president of Evercore ISI, a consultant, said Lagarde’s speech was intended to back up the idea that the ECB would bring about a global turnaround in the tide while the Fed moderately hawkish and the Bank of England moves become sharp hawk ”.

Inflation in the eurozone rose to a decade-high 3 percent in August, well above the ECB’s target of 2 percent. Economists say it could rise to 4% by November, driven by higher energy prices, supply chain bottlenecks and rising demand – although they expect inflation to disappear next year.

Line chart of the harmonized index of consumer prices (annual% change) showing that the ECB expects inflation to fade

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

“Once these pandemic-driven consequences pass, we expect inflation to fall,” she said. “Monetary policy should normally review temporary inflation provided by stocks, as long as inflation expectations remain anchored.”

Wholesale prices have more than quadrupled in Europe this year, contributing to a sharp rise in wholesale electricity prices and the disruption of sectors relying on gas by-products, such as fertilizer manufacturers and food packaging.

Lagarde cites 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 are not used to mitigate the impact of higher energy prices on households, it could “reduce purchasing power and lead to relative price changes that could lower underlying inflation”.

This month, the ECB slow down of its mortgage 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 its plans to end its € 1.85 million bond purchase program in December and publish inflation forecasts for 2024.

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