ECB Insight: Lagarde’s Who-Could-Have-Ever-Imagined Act

28 June 2021

By David Barwick – FRANKFURT (Econostream) – What a difference a few weeks make. After suggesting in late May that the strength of the economic recovery was no better than as expected and actually not all that robust, European Central Bank President Christine Lagarde now seems to be contemplating the positive evolution with eyes wide and jaw slack.

On May 21, she dismissed the latest indications of an unambiguously improving economic context, saying that ‘[t]here were quite a lot of factors and development that we are seeing at the moment that were actually already included in our previous projection from last March.’

Moreover, while pre-pandemic output levels would be regained next year, the recovery is uncertain and uneven, she said. For this reason, policy support ‘will continue to be necessary in the months to come in order to make sure that recovery is actually well underway’, she said.

Fast-forward to last Friday, when she professed surprise at the strength of the euro area’s economic rebound. ‘The euro area economy is bouncing back faster than anticipated, but the recovery is only just underway’, she said in a post on LinkedIn under her name.

Of course, that was not all she said. ‘Monetary and fiscal policies must continue to support each other to prevent the pandemic leaving lasting scars’, she added.

The call for sustained policy support is a given, but that the euro area could be recovering at a pace unforeseen is all the more surprising in view of Lagarde’s steadfast refusal to speak of upside risks until recently. In her world, the downside risks to the economy have been so predominant that a faster-than-anticipated rebound is less a case of upside risks materialising than it is an out-of-the-blue turn of events.

How could this occur? Simply put, Lagarde – as has been argued in this space for months – has been unwilling to duly acknowledge an improved economic landscape out of fears that the markets would understand an expression of optimism to be implicit stage-setting for a withdrawal of the ECB’s extraordinary measures.

That did not change until the comments made one month ago today by her Executive Board colleague, Isabel Schnabel, who clarified in an interview the meaning of the hitherto undefined ‘crisis phase’ during which the ECB’s emergency support measures needed maintaining.

The pandemic, Schnabel said, was not what really mattered. Rather, ‘the main thing to look at is the inflation projection’, she said. ‘This is the ultimate yardstick against which we measure whether the emergency is over, since we said that our tools are meant to offset the negative effect of the pandemic on the inflation outlook.’

With that, Schnabel made clear that brighter economic prospects also did not make much difference per se. That allowed her to admit to an improvement in the environment with a frankness not previously seen from the ECB Executive Board, and laid the groundwork for Lagarde to start doing the same at the June 10 press conference.

Of course, at some point it would have been way too late to change tack safely, and further deferral of the inevitable would have come at mounting cost. Indeed, it is probably safe to say that some at the ECB think Lagarde is still in danger of missing the curve.

Seen that way, her comments Friday represent the ideal concession to that line of thought: the admission on an otherwise meaningless LinkedIn post that the bounce-back is faster than projected lets Lagarde introduce a distinctly more hawkish note into the discussion about as casually as ECB communication allows. This is in effect how Lagarde seeks to walk back months of unwillingness to call a spade a spade, and presages more of the same.

More candour from the get-go would have probably been preferable. As it is, the who-could-have-ever-imagined act by Lagarde will for some observers just underscore the fact that the ECB has sacrificed candour to its determination to keep policy as accommodative as possible for as long as possible. And that may remain the perception even if the ECB manages to take the curve without any accidents.