ECB Insight: Lane Laying the Groundwork for the ECB to Underdeliver?

11 October 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank Chief Economist Philip Lane’s speech on Monday raises the possibility that the ECB is even less inclined to withdraw support than previously thought.

Given the contribution of services to overall inflation and the importance of wages for service sector inflation, ‘the persistent component in wage dynamics plays a central role in the determination of underlying inflation’, he said.

That of course is perfectly reasonable and entirely consistent with what was already known about how the ECB is thinking. Lane however heads in a somewhat new direction from here, drawing the conclusion that assessing progress in the realised path of underlying inflation – which relates to one of the three conditions of the reworked forward guidance for a rate hike – requires ‘differentiating between transitory and persistent shifts in the growth rate of wages’.

That is already somewhat unusual, as the ECB, at least publicly, has not recently drawn attention to such a distinction, though it seems natural enough to make. The key sentence follows: ‘In particular, a one-off shift in the level of wages as part of the adjustment to a transitory unexpected increase in the price level does not imply a trend shift in the path of underlying inflation.’

Lane doesn’t pursue that thread, but this view essentially implies that higher wages, which the ECB has insisted for quite some time would be needed to see sustainably stronger inflation - but which it has also claimed to perceive little or no evidence of - clearly won’t be sufficient per se to hike rates.

Doubling down on the idea that not all wage and price pressures count for purposes of the ECB’s monetary policy stance, Lane then takes on the ongoing increase in energy prices. These, it turns out, are also a mixed blessing at best even in the limited context of the desire for higher inflation, because of ‘the associated headwinds for the economic outlook and the negative wealth effect associated with a deterioration in the terms of trade’, he said.

‘Through these mechanisms, an energy price shock can simultaneously raise headline inflation but exert downward pressure on the path of underlying inflation’, he added.

That idea is not controversial, so the point is more that Lane is evidently out to throw water on the idea that the policy tightening conditions under forward guidance stand any chance of being met soon.

The remainder of his relatively short speech, none of which could be considered anything but dovish, also backs up this idea, including his highlighting of two ‘basic conclusion[s]’ of the ECB’s strategy review that amounts to a repeat of the strategy statement and more than anything else suggests a desire to emphasise the ECB’s well-known determination to avoid any premature policy moves.

At the current juncture, policy comments made by members of the Executive Board might be best considered in the context of the question of what the ECB will do if the prevailing uncertainty hasn’t diminished significantly by December’s Governing Council meeting.

While the ECB has apparently committed to making important decisions in December and seems likely to follow through, it is bound to be aware that taking major steps in an environment that remains unexpectedly opaque would be inconsistent with its insistence on minimising the risk associated with moving too soon.

Could Lane be laying the groundwork for the ECB to potentially underdeliver on December 16? It is possible, but this far ahead, there is little need to do so more explicitly. If eventually deemed to be warranted, more explicit communication will follow.