ECB Insight: Lagarde Sows Doubts About Usefulness of Current HICP Projections

27 September 2021

By David Barwick – FRANKFURT (Econostream) – Of the possible takeaways from European Central Bank President Christine Lagarde’s European Parliament Q&A on Monday, a prominent candidate might be that the Eurotower doesn’t put too much stock in its latest inflation projections.

Nothing Lagarde or others have been saying recently indicates a great deal of faith in the durability of those projections, and her appearance before EU Parliament was no exception. It was naturally clear that the issue for her was whether the current forecasts would turn out to have erred on the downside:

‘Now [the outlook] will be readjusted and reviewed at each and every projection that we publish, and we will next time review it in December, when we probably have a better idea, in particular concerning supply bottlenecks and whether or not they’re going to continue to impact and put upside pressure on prices’, she said.

It is worth recalling that the exercise producing the current forecasts was only earlier this month, meaning the ECB is calling its outcome into question, at least subtly, with unusual speed.

That the current forecasts are little more than placeholders until the ECB is better placed to make predictions is a theme that emerged yet again during the hearing.

‘We are going to take numbers and projections as they come, and clearly December is going to be a time when we will assess, March will be another time, June will be another time’, she said. ‘And we are very careful not to jumpstart and anticipate what numbers will be.’

Lagarde naturally repeated various times that the factors driving current inflation were ‘largely temporary’, but reassured her audience that the ECB would ‘monitor very carefully’ the persistence of the supply bottlenecks, the results of wage negotiations over the coming months, and whether the use of savings would lead to demand-based price pressures.

The ECB would also watch ‘very, very carefully’ to see whether the new strategy framework and the correspondingly revised forward guidance would support, ‘as we are beginning to observe, anchoring of inflation expectations at higher level than what we have seen for a long time’, she said. The ECB is ‘very attentive’ to this, she emphasised at another point.

Also interesting during the hearing was the response to a member of the Committee on Economic and Monetary Affairs wishing to know about prospects for ECB purchases of Greek bonds. Might, based on Lagarde’s answer, some important decisions currently expected in December be deferred just a bit longer? Econostream was wondering previously about such a scenario.

‘We will have to actually assess what is the overall framework within which we conduct our monetary policy, which tools will we use and under what conditions of eligibility bonds are purchased’, Lagarde said. ‘Under PEPP, Greek bonds are eligible, under the current APP they’re not eligible. But these matters will be reviewed in due course in probably late ‘21, early ’22.’

The ‘early ‘22’ may have been a lapse of no particular significance, of course. Queried again later on the subject of Greek bond purchases, Lagarde corrected herself, consciously or otherwise, on the matter of when such decisions would be forthcoming: ‘And this is, as I said, an exercise that will be conducted at the end of ’21.’

One thing that was more clearly not news was Lagarde’s take on what constitutes the medium term. Invoking the ECB’s current forward guidance, she said the Council wanted ‘to make sure that there is realised progress in underlying inflation, that they are sufficiently advanced to be consistent with inflation stabilising at 2% over the medium term.’

The question, she noted, is how the medium term is defined. It is not ‘necessarily the end of our projection horizon’, she answered. ‘It could be further out. … the exact duration is not to be defined and cannot be defined, because it’s a factor of the size of the shock, of the source of the shock, of the persistence of the shock that hurt the economy.’

While the medium term is often thought to mean two to three years in the context of European monetary policy, Lagarde’s explanation is consistent with the ECB’s previously stated view. In February 2020, Executive Board member Isabel Schnabel offered the same interpretation in a speech.

‘How long the medium term is depends on various factors, including the nature, size and persistence of economic shocks’, Schnabel said.

Since then, the ECB revamped its strategy framework, but nothing about that is known to have changed the meaning of ‘medium term’, to which the ECB’s monetary policy remains oriented.

This understanding of the medium term is also to be found on the ECB’s website. The page dedicated to an explanation of the medium-term orientation asserts that ‘the optimal monetary policy response to ensure price stability always depends on the specific nature and size of the shocks affecting the economy.’