Lagarde faces widening division at ECB over Europe’s inflation path

Christine Lagarde, president of the European Central Bank.

A rift is opening at the European Central Bank over how rapidly monetary policy should respond to stubbornly high inflation. A key meeting to determine the fate of post-pandemic stimulus is just six weeks away, and opinions are diverging on whether price pressures will mostly fade or endure. The debate is unfolding as global policy makers try to balance the risks of acting too quickly with those of not moving soon enough, and as a new coronavirus wave engulfs Europe. The official ECB line is that inflation will stay elevated for longer than previously thought before slowing once supply chains recover and temporary factors wane. President Christine Lagarde has dismissed the possibility of an interest-rate increase in 2022 as “off the chart.” But there were signs this week that not all 25 Governing Council members are in complete agreement on the inflation outlook. Vice President Luis de Guindos warned of a more protracted period of lofty prices. “Inflation next year will slow without a doubt.” he said yesterday. “But the intensity and speed of the decline may not be what we expected a few months ago.” Slovenia’s Bostjan Vasle concurred, while Ireland’s Gabriel Makhlouf said he’d prefer to act sooner rather, if necessary. “I’m more prepared to take earlier action than later action, if we if we feel the need to react,” he said. “Right now, I’m comfortable with our policy stance” but “we need to be absolutely vigilant.” Surging global prices have prompted central banks from New Zealand to Mexico to raise interest rates. Just outside the euro area, Poland and the Czech Republic surprised with bigger-than-expected hikes this week. While euro-area inflation breached 4% in October, ECB forecasts show it slowing to 1.5% in 2023. That’s insufficient to justify higher rates based on policy makers’ latest manual that says projections must show price growth at 2% for some time before such a step can be considered. “Despite the current inflation surge, the outlook for inflation over the medium term remains subdued,” Lagarde said on Wednesday, pushing back against investor bets for a rate increase in 2022. As well as helping drive down money-market wagers on a hike to 10 basis points of tightening by November next year from 20 basis points a week ago, Lagarde’s view found plenty of support among her colleagues. Executive Board member Isabel Schnabel said on Thursday that a “premature tightening of monetary policy would hurt economic growth and it would negatively affect employment.” The ECB is “assured that the current inflation spike is temporary,” according to France’s Francois Villeroy de Galhau, who said “there’s no reason for the ECB to raise its interest rates next year.” Mario Centeno, Portugal’s central-bank chief, warned against choking the economy, saying a short-lived recovery must be avoided “at all costs.” Estonia’s Madis Muller expressed doubts that inflation is “consistently at a stable 2% level.” Policy makers agreed in October that price growth would exceed that rate on average next year, though couldn’t agree on where it would settle in 2023. New forecasts will be available in December, when the ECB is expected to announce the end of its pandemic bond-buying programme next year. For now, its policy direction is unlikely to change - especially with those more dovish officials able to argue that there’s little harm in allowing inflation to overshoot the 2% target for a while after falling short for nearly a decade. “The ECB is likely to stick to its assessment for the time being and not initiate a normalisation of its monetary policy,” said Joerg Kraemer, chief economist at Commerzbank AG. “Even if these bottlenecks persist and inflation rates therefore exceed expectations in the first months of the coming year, this is unlikely to shake the ECB’s inflation picture.”