ECB Insight: Upending Her Own Rates Guidance, Lagarde Wants to Be Seen as Frontloading, Not Overdelivering

21 July 2022

By David Barwick – FRANKFURT (Econostream) – The European Central Bank on Thursday may have over-delivered with respect to its new anti-fragmentation instrument, even discounting somewhat low expectations, while on the interest rate front we see it as an open question whether it is in the process of over-delivering or has merely frontloaded what the Governing Council intended anyway.

As Econostream wrote on Tuesday about the new policy transmission safeguard, ‘failure to deliver would be an emperor-has-no-clothes moment that the ECB can ill afford, meaning that [President Christine] Lagarde has to have considerably more than a programme name’, and so she did.

At the last minute, Council members converged around a proposal and, as she reported at the subsequent press conference, unanimously supported the so-called Transmission Protection Instrument. She was not as stingy with details as some anticipated, even if she exhorted listeners not to expect all particulars, ‘because there is an element of discretion and judgment … and there are some elements that are best left unpublished, undisclosed and uncommented upon.’

Her attitude towards the new tool, whose volume ex ante is unlimited (‘the ECB is capable of going big’, she said), was one of clear confidence that no one called into question by inquiring whether the ECB reckoned with legal challenges.

To be sure, asked about its immediate relevance for Italy, she evaded the query with a rather scripted non-answer. But it was clear all the same that the Council’s ability to unite to the last member around what she described as the ‘strong and powerful’ TPI had emboldened monetary authorities, a fact she alluded to various times.

Indeed, the agreement was, as Econostream had said, the sine qua non of the larger-than-expected rate step taken by the ECB. In effect, she said in explaining the latter decision, ‘the situation has changed in relation to transmission.’

A combination of the ‘realisation of upside risks to inflation’, the initiation of flexible reinvestment of securities purchased under the pandemic emergency purchase programme (PEPP), ‘and, more importantly’, the approval of the TPI had led to the choice of 50 basis points, she said.

Lagarde acknowledged that in opting for the bigger move, the Council had contradicted its own guidance. ‘[W]e had the debate, weighted the pros and cons, and at the end of the discussion, all members of the Governing Council rallied to the consensus of 50 basis points’, she said.

Whether the decision might ultimately take borrowing costs higher than they would have gone otherwise must remain an open issue for now. Lagarde sought to dispel the impression.

‘Does that mean that we are changing … the terminal rate at which we want to arrive?’, she asked. ‘No.’

At the same time, however, the 50 basis points previously envisaged for September’s hike (‘Some of you have assumed that it might be 50’, she coyly said) are now subject to question, as the ECB is ‘not offering forward guidance of any kind’ given today's frontloading, she maintained.

On the other hand, neither was anything ruled out. The ECB ‘will be operating month by month, meeting by meeting on the basis of data, and we will adjust and calibrate accordingly’, she said.

As her rhetoric concerning inflation was anything but relaxed and she assured that ‘we are definitely on a normalisation path’, the assumption that a hike of 25 basis points now becomes the benchmark for September, when the staff macroeconomic forecasts will be updated, would be premature at this stage.

A more apt conclusion – in addition to the reminder that the Council tends to overcome great divergence and find common ground when seated around a single table – is the general one that Lagarde’s guidance, while warranting more than a grain of salt, should be seen as substantially less than ironclad, so that its omission matters little.

As on Tuesday, we reproduce again the words with which Lagarde eventually explained away her own repeated dismissals of a 2022 lift-off: ‘On the other question of the rate hikes: you know, I never make pledges without conditionalities and it is even more important at the moment to be very attentive to that.’

Lagarde didn’t make any pledges today about the magnitude of the next moves, but under the circumstances, that’s just as well. It will be up to time and data to tell whether today’s 50-basis-point hike was over-delivery. If markets swallow the TPI, we see good chances that it was, and expect at least the Council hawks to feel the same way.