ECB’s Weidmann: Post-Pandemic Demand Won’t Sustainably Boost Inflation

1 April 2021

By David Barwick – FRANKFURT (Econostream) – A post-pandemic wave of pent-up demand would not lead to sustainably higher inflation, though other forces could contribute to faster future price growth, European Central Bank Governing Council member and German Bundesbank President Jens Weidmann said Thursday.

The projected increase in euro area inflation this year is due chiefly to ‘special effects’, he said in comments to the International Club of Frankfurt Economic Journalists, and the upward trend in subsequent years could turn out even weaker than thought. However, stronger-than-expected developments are also possible, he said, citing the effect of higher commodity prices on intermediate goods.

Moreover, private household savings in 2020 were €110 billion more than in 2019, he said, though demand would probably be ‘far less’ than this and ‘increased competition for the pent-up demand’ could also limit price rises.

‘Either way, catch-up effects would not fuel inflation in the long run’, he said. ‘A permanently stronger increase in inflation would require noticeably higher wage growth. We do not see that at present.’

Structural factors like the greening of the economy with associated higher prices for greenhouse gas emissions, digitalisation and demographic changes could also affect price developments in the coming years, he said.

‘It is important to remain vigilant and to observe these developments closely’, he said. ‘I have been pointing out for a long time that it would be negligent to rule out the possibility that we may have to deal with more inflationary forces again in the future.’

The economic outlook is uncertain, being tied to pandemic developments, he said; once these are under control, recovery should be quick, but this could take longer than assumed at the time of the March ECB forecasts.

‘In this case, the GDP growth forecast for the euro area in 2021 might no longer be sustainable’, he said. ‘But even then, the economy could still reach the activity level expected in the March forecast at the end of this year’, provided immunisation progress allows economic re-opening.

Simply considering the indicators of financing condition favourability ‘is not enough’, he said, as the underlying reasons ‘can be quite decisive in determining whether monetary policy should react or not.’

An increase in nominal interest rates that reflected expectations catching up to the ECB’s price stability objective ‘would be a welcome development’, just as a rise in real interest rates due to a brighter economic outlook, he said.

Moreover, the financing conditions relevant for companies and private households ‘only react to interest rate changes in the upstream transmission levels if the interest rate changes also last relatively long’, he said.

As for the recent rise in German government bond yields, this was mainly due to better economic prospects in the U.S., but also to improvement in the euro area, he said. In addition, euro area inflation expectations had moved in the direction of the ECB’s objective, he said.

Interest rate changes must therefore also be considered in real terms, he said. ‘Most recently, market-based inflation expectations (the 5y5y forward inflation rates) were slightly above 1.5%, even higher than before the Corona crisis’, he said.

These expectations probably incorporate downside bias, he said, being based on bond prices that in addition to inflation expectations also include liquidity and risk premia as expressions of investor preferences.

Still, Weidmann characterised the ECB’s March 11 decision as forward-looking, inasmuch as higher risk-free interest rates and sovereign bond yield could affect other areas via bank lending rates.

‘It is possible that a significant and sustained rise in market interest rates would prematurely tighten financing conditions’, he said. ‘This could weigh on the economic recovery and set us back on the path to price stability.’

The decision to significantly increase the pace of PEPP purchases in 2Q ‘has not changed the maximum volume of the programme’, he said.

Weidmann reiterated his fears that high government debt could prove an obstacle to the normalisation of monetary policy, if central banks ‘come under growing political pressure to ensure the sustainability of government debt by maintaining loose monetary policy longer than medium-term price stability requires.’

‘Monetary policy must then remain firm’, he said. ‘And in order not to raise false expectations, we should make this clear already today: Emergency monetary policy measures must not become permanent. They must remain closely tied to the crisis and be terminated after the pandemic. In addition, the ECB Governing Council must scale back the very expansionary orientation of monetary policy as a whole if the price outlook so requires. Then there must be no lack of resolve, even if the financing costs of the states rise with the interest rates. This is important for the credibility of monetary policy.’