ECB’s Lagarde: Adjusting the Pace of Rate Hikes is a Key Signalling Tool
20 September 2022
By David Barwick – FRANKFURT (Econostream) – European Central Bank President Christine Lagarde on Tuesday said that the size of the Governing Council’s rate hikes was a way of signalling its firm intention to safeguard price stability and thus to keep expectations in check.
In a speech before a business and industry association, Lagarde described the situation as one in which ongoing supply bottlenecks, aggravated by pent-up demand, were prolonging the period of elevated inflation.
‘[W]e need to normalise policy, and be ready to adjust rates by as much as necessary to reach our inflation target in the medium term’, she said. The speed chosen for this adjustment, given the unusually low starting point of interest rates, ‘can mobilise the signalling channel of monetary policy directly’, she said.
‘In this context, especially compared with the traditional focus on 25 basis-point increments, adjusting the pace of rate hikes is a key tool to signal our determination to fulfil our mandate and keep inflation expectations contained’, she said. ‘And moving faster at the start of the hiking cycle clearly conveys our commitment to bring down inflation to our medium-term target.’
Although expectations are currently still ‘relatively well anchored’, the disproportionate price increases of everyday items have the potential to boost household expectations, she said, citing the one-point rise since February in mean and median three-year inflation expectations as measured by the ECB’s Consumer Expectations Survey.
Also, she said, the abruptness of the change in the inflationary environment can lastingly affect expectations.
The larger-than-anticipated rate hikes in July and September were motivated by the need to contain inflation expectations and ‘has sent a strong signal of our determination to return inflation to our medium-term target in a timely manner’, she said.
‘This major step also took into account the unusually low level of interest rates and the limited risk of overreacting at the start of the hiking cycle’, she continued. ‘Going forward, the appropriate pace of future rate increases will be decided on a meeting-by-meeting basis.’
The terminal rate and the magnitude of rate hikes to get there will be determined by evolving inflation prospects, she said.
An important determinant of the terminal rate will be the impact of the current supply shocks on expectations and potential output, she said.
‘If there were evidence that high inflation risked de-anchoring inflation expectations, then the policy rate that is compatible with our target would lie in restrictive territory’, she said. ‘Similarly, were we to conclude that ongoing supply shocks had durably lowered economic potential, we would have to ensure that demand remains aligned with supply.’
Historically, negative supply shocks have also slowed growth and thus inflation, the latter typically decelerating by some 1.1 points at the one-year horizon, she said. But this is by no means always the case, and the ECB’s adverse economic scenario projects higher medium-term inflation than the baseline, she noted.