ECB Insight: Lagarde Speech Strikes New, More Optimistic Inflation Tone

22 November, 2021

By David Barwick – FRANKFURT (Econostream) – European Central Bank President Christine Lagarde on Friday warned of the negative growth impact from the developments driving high inflation, but the clearly more important takeaway was her new optimism about the possibility of inflation eventually getting to the point where the ECB could start raising interest rates.

In a speech at the Frankfurt European Banking Congress, Lagarde again argued that the drivers of inflation were likely to dissipate in the medium term, ‘the horizon that matters for monetary policy’, but ‘will probably slow the pace of the recovery in the near term.’

That is not new; for example, speaking to the Committee on Economic and Monetary Affairs of the European Parliament at the beginning of the week, Lagarde had stated that ‘growth momentum is moderating to some extent owing to supply bottlenecks and the rise in energy prices.’

On Friday, she also reiterated a closely associated point that is by now part and parcel of ECB communication, namely that given the transitory nature of inflation, the ECB would not ‘rush into a premature tightening’, especially since ‘an undue tightening would represent an unwarranted headwind for the recovery’.

More interestingly, Lagarde then made a statement of the kind that not long ago would have been less easily imaginable coming from her: ‘However, as positive demand forces in the economy gain strength, the inflation outlook over the medium term is looking better than it did before the pandemic.’

Though she also called on this as yet more reason to ‘continue nurturing these forces by not withdrawing policy support prematurely’, the message, and others that followed, nonetheless appear to constitute somewhat of a shift in communication about the ECB’s view of prospects for a recovery of inflation beyond the medium term.

As an illustration of this, one might consider Lagarde’s speech in Lisbon on November 3, when she noted the conditions of forward guidance for a rate hike and said that ‘these three conditions are very unlikely to be satisfied next year.’

In that same sentence, she also said that ‘[d]espite the current inflation surge, the outlook for inflation over the medium term remains subdued’.

On Friday, Lagarde also asserted that ‘the conditions to raise rates are very unlikely to be satisfied next year’, but avoided downplaying the medium-term inflation outlook.

To be sure, the last staff forecasts would have backed her up had she chosen to say this, as the September projection exercise envisioned 2023euro area HICP at 1.5% - and thus arguably ‘subdued’.

But the validity of this forecast was already questioned at the time, appearing as it did to err on the low side. Two and a half months later and with just under four weeks to go to the next forecast updates, characterising the inflation outlook now on the basis of the September projections – whether for this year, next or 2022 – would look detached from reality.

This is not to say that the revised 2023 forecast – or the brand new 2024 projection due out next month – will necessarily be inconsistent with the statement that the medium-term inflation outlook remains subdued. Lagarde presumably does not know yet.

What she does realise is that it has become markedly more possible that the next set of forecasts will be less consistent with calling the medium-term inflation outlook ‘subdued’. That awareness seems likely to have led to the less pessimistic language of her latest speech.

Of particular interest in Lagarde’s speech on Friday was the final paragraph before her conclusion. Her conclusion amounted to nothing more than a repetition of previous points, but the previous paragraph suggested a surprisingly optimistic view of where inflation developments might be headed.

‘GDP should reach its pre-pandemic level before the end of this year’, she said. ‘Inflation expectations are rising towards our target. Measures of underlying inflation are moving in the right direction.’

‘And wage growth, which is a key element of underlying inflation, should start to gradually strengthen’, she continued. ‘The ECB’s recent contacts with large European companies suggest that wage growth will pick up somewhat next year.’

All this is new from Lagarde; among Executive Board members, only Isabel Schnabel has stood out for months as a proponent of the idea that the current constellation of circumstances represents an opportunity for the ECB to get away from the low inflation of recent years.

With ECB speeches, some caution is always warranted. Did Lagarde truly mean to strike a fundamentally different tone, or was Friday’s text just an aberration, ‘noise’ resulting from a huge bureaucracy’s difficulty in applying a rigorous approach to the drafting of communication?

One would prefer that the former be the case, but this is not necessarily so. Still, the Frankfurt European Banking Congress has traditionally been an occasion of sufficient significance for the speech given there by the respective ECB president to be taken particularly seriously.

Referring to the three conditions for a rate hike not currently seen as standing much chance of being fulfilled next year, Lagarde on Friday voiced the hope that ‘if we are patient and persistent now, I am confident that these conditions will eventually be met.’

If in fact she now feels such hope, it will resurface in her upcoming interventions.