ECB’s Lagarde: Appropriate to Normalise Balance Sheet in Measured, Predictable Way

18 November 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank President Christine Lagarde on Friday indicated that normalisation of the ECB’s balance sheet would take place cautiously and gradually, and would be subordinate to interest rates in determining the stance of monetary policy.

Speaking at the European Banking Congress, Lagarde said that whilst massive asset purchases were needed near the lower bound of interest rates, ‘in the current environment, and acknowledging that interest rates remain the most effective tool for shaping our policy stance, it is appropriate that the balance sheet is normalised in a measured and predictable way.’

In December, the Governing Council would set forth the key principles for the unwinding of the ECB’s balance sheet, she reiterated.

‘In parallel, our tools for preserving the orderly transmission of monetary policy − notably flexible reinvestments under the pandemic emergency purchase programme and the new transmission protection instrument − will remain in place’, she added.

As for interest rates, which she insisted would remain the ECB’s ‘main tool’, these were expected to be hiked further, she said. However, ‘withdrawing accommodation may not be enough’, she continued. ‘Ultimately, we will raise rates to levels that bring inflation back down to our medium-term target in a timely manner.’

The terminal rate and the speed with which this is reached depend on inflation prospects, she said. ‘This is forward-looking and incorporates all the different forces we are facing: the outlook for the economy, the persistence of the shocks, the reaction of wages and inflation expectations, and the transmission of our policy stance’, she said.

Euro area inflation was ‘far too high’ and ‘likely to remain high for an extended period’ obliging monetary authorities ‘to monitor the evolution of inflation expectations very carefully’, she said. Moreover, recessionary risks have mounted, although even a downturn would probably not reduce inflation notably, ‘at least in the short run’, she said.

‘In this setting, displaying commitment to our mandate is vital to ensure that inflation expectations remain anchored and second-round effects do not take hold’, she said. The 200bp of tightening so far ‘send a clear signal to the public of our determination to bring down inflation, which will help anchor expectations’, she said.

The ECB would ‘take the necessary measures’ to restore price stability, she assured.

Lagarde observed that some current supply constraints ‘will fade over time’, citing shipping costs and delivery times. ‘But other changes may well be more persistent’, she said, as shocks related to the pandemic and the war lead to a ‘“new global map” of economic relationships.’