From the ECB, a Subtle Change of Tone on the Inflation Outlook

2 March 2021

By David Barwick – Frankfurt (Econostream) – An interview with European Central Bank Vice President Luis de Guindos published Tuesday by Portuguese daily Público offered a subtle but telling glimpse into the evolving thinking of Europe’s monetary policymakers.

In particular, comments made by de Guindos on inflation implicitly suggested that the central bank may see a growing need to rethink things. Though staff forecasts slated to be unveiled anew next week are not yet finalised, he said, HICP this year would be ‘above 1% on average’ and thus more than ECB staff envisioned in December, when they issued updated projections calling for exactly 1%.

De Guindos chose to leave it wide open as to how much above 1% the new projection would be. Given how little it would have cost to say ‘slightly’ above 1%, an admissible interpretation of the failure to do so is that a more significant upward revision could potentially be in the offing.

Such an interpretation would suit well most of the rest of what de Guindos had to say on the subject. Asked whether he was worried that expansionary policies could lead to very high inflation, he prefaced his answer by noting opposing effects, thus immediately conceding ground by electing not to focus on downside forces, as the ECB has tended to do.

Indeed, though de Guindos mentioned weak demand – presumably meaning only domestically - he was decidedly more vocal about upside price pressures, elaborating that ‘there is a great deal of monetary and fiscal stimuli, plus an increase in commodity prices and the recovery in world demand.’

While he allowed that ‘we do not need to be very concerned about inflation in the short term’, this amounts to a fig leaf, and not merely because not needing to be ‘very’ concerned isn’t all that reassuring. More fundamentally, the ECB’s concept of price stability follows a medium-term orientation, so the ECB tends to look through short-term developments.

By then noting the existence of ‘structural factors that could push inflation up all over the world’, in which context he cited supply chains that would become more regional and a slowdown of globalisation, de Guindos was in effect saying not to worry all while explaining why inflation could in fact surge.

De Guindos sounded somewhat more relaxed on the subject of inflation less than a month ago. Speaking on February 5, he said, ‘We do not believe that we are going to see … an important increase in inflation over the next quarters.’

In general, the ECB would like to see higher inflation in line with its price stability mandate. If inflation were to rise too quickly, however, it would lead to calls to withdraw monetary policy support considerably faster than the ECB would like to or has been suggesting it would need to.

A tightening of the policy reins could jeopardise a recovery that is only expected to take off in the second quarter, as containment measures are lifted – de Guindos in fact said that not only 1Q, but 2Q as well could turn out ‘relatively weaker than expected’ - and growth can resume unimpeded.

It would also put pressure on governments for which rock-bottom borrowing costs have made the pandemic-associated increase in debt feasible.

Of course, it may still be early even to speculate about when inflation prospects might be consistent with the winding down of monetary policy measures, and de Guindos only suggested that there could be a need for the opposite to occur yet again.

In particular, if the ECB were to decide that the increase in nominal yields was negatively affecting financing conditions, he said, ‘then we are totally open to recalibrating our programme including the envelope of our pandemic emergency purchase programme (PEPP) if necessary. We have room for manoeuvre, and we have ammunition.’

Still, he said, the ‘good news’ is that spreads have held steady amid rising nominal yields, confirming the effectiveness of ECB measures in containing fragmentation.

De Guindos described the underlying character of the nominal yield rise as ‘the key factor’ for ECB monetary policy. Monetary authorities must assess whether the increase reflects inflation trends or ‘whether there are other factors that could hinder economic recovery’, he said.

Either way, with just over a week until the next monetary policy meeting of the Governing Council, the concerns with which de Guindos is clearly grappling set the stage for a more interesting occasion than might have been expected until recently.