ECB Insight: Lagarde Excludes Full-Bore Approach to QT, Stressing Primacy of Interest Rates

18 November 2022

By David Barwick – FRANKFURT (Econostream) – Comments made by European Central Bank President Christine Lagarde on Friday effectively excluded a full-throated initial approach to unwinding the ECB’s balance sheet.

Speaking at the European Banking Congress, Lagarde made clear that ‘interest rates remain the most effective tool for shaping our policy stance’ and would enjoy primacy over quantitative tightening.

As well, she called it ‘appropriate that the balance sheet is normalised in a measured and predictable way.’

As we observed yesterday, there are differences between Council hawks’ and doves’ respective levels of passion for embarking on QT, but across monetary policy philosophical lines, authorities seem to want to proceed with caution.

Along with the doves, whose desire to go slow in this area is no surprise, we note in this respect comments from Mārtiņš Kazāks (‘We should not delay the start of QT too much, but at the same time we should be cautious, because we want the transmission mechanism to work.), Pierre Wunsch (‘Honestly, there is no reason why we should keep buying sovereign bonds, but at the same time we don’t have a lot of information of what it would mean to stop QE, and I would be for [being] cautious there.’) and Robert Holzmann (‘We are careful because the financial markets are to a greater extent uncertain than maybe a half a year or a year ago.’).

Lagarde has now positioned herself similarly. From our point of view, a possible implication of this is that it may diminish the capacity of progress in terms of QT to take up the slack if the ECB were to decide to reduce the magnitude of its rate hikes - 75bp in October and September - and thus to help ensure that the ECB is not perceived as having gone soft on inflation well before HICP has even peaked.

In conjunction with her emphasis on continuing to favour interest rates as ‘the main tool for adjusting our policy stance’, this could raise the question of whether a deceleration on the standard policy front will be possible as soon as some anticipate.

Lagarde did not share her thinking on this question explicitly, merely reiterating that central bankers ‘expect to raise rates further’ and that ‘withdrawing accommodation may not be enough’, and sidestepping in her accustomed manner the matter of the terminal rate and the rapidity with which this will be attained.

On the other hand, she also repeated her assessment of inflation as ‘far too high’ and ‘likely to remain high for an extended period’ with or without recession. ‘In this setting,’ she said, ‘displaying commitment to our mandate is vital to ensure that inflation expectations remain anchored and second-round effects do not take hold.’

Drawing conclusions from all this with respect to the likely size of the December rate hike is difficult, but that is no accident. As we have said before, the ECB is itself unsure, understandable enough under conditions of such extreme uncertainty.

With a month to go to December's monetary policy meeting and a meeting-by-meeting, data-driven approach dominating, multiple options may remain on the table for some time yet. For Lagarde to leave the question open for now thus makes sense.

Still, with her significantly more hawkish Council colleagues Joachim Nagel and Klaas Knot on the agenda later today, a more explicit hint may yet come.