ECB Insight: Lagarde Unmistakably Hawkish; ‘It Would Surprise Me’ if Inflation Already at Its Peak

28 November 2022

By David Barwick – FRANKFURT (Econostream) – European Central Bank President Christine Lagarde on Monday showed herself from her hawkish side, making it considerably less clear whether the Governing Council would really temper its pace of rate hiking as soon as next month, but also raising the question of how bold forthcoming quantitative tightening decisions will turn out.

Notwithstanding the relatively neutral tone of the prepared remarks she had just delivered at European Parliament, Lagarde said during the ensuing Q&A that ‘[h]eadline inflation, the one that we look at most, has hit its highest reading in October … core inflation as well has been very high … I would like to see inflation having peaked in October, but I’m afraid that I would not go as far as that.’

The chief reason for doubting that inflation was about to show deceleration was the pass-through of higher energy prices from the wholesale to the retail level, she said.

‘It would surprise me’ therefore if inflation had already run out of steam, she said. ‘Obviously in the longer term, inflation will decline, if only because of our monetary policy, number one, but also because bottlenecks … will gradually fade out.’

For now, however, ‘we do not see the components … that would lead me to believe that we have reached peak inflation and that it is going to decline in short order’, she said.

When she asks ECB economists, ‘the answer that I get for the moment is that risk is to the upside, without qualifying … that prompts us to continue to tame inflation with all the tools that we have,’ she said, with interest rates being ‘first and foremost’ among those tools.

Monetary policy at the moment ‘is still accommodative, by the way’, she noted.

Asked about the likely extent of ECB hiking, Lagarde replied, ‘I don’t have the answer to that question … the ECB will use interest rates and will hike interest rates as long and as much as is needed in order to reach the price stability medium-term target that we have.’

‘We are not done with inflation and we still have work to do’, she added. ‘Whether that will take us into restrictive territory, it may well be.’

Ultimately, the terminal rate ‘has to be the interest rate that will be sufficiently high’ to ensure the ECB achieves its objective, she said, repeating the willingness to tighten to the point of restrictiveness. But this, she reminded, monetary authorities ‘will be debating meeting by meeting and on the basis of data.’

‘We are still providing support to demand, we are still in accommodative territory … in the face of what we are trying to do, which is tame inflation … we clearly have to continue increasing interest rates’, she said. ‘My suspicion…is that we still have a way to go, and we are not done with inflation.’

‘[W]e have to stop stimulating demand’, she said.

Lagarde criticised national fiscal policies, which she had urged in her prepared remarks be temporary, targeted and tailored so as not to create additional price pressures.

‘Not all of it is temporary, targeted and tailored’, she said. ‘Some of those measures which are taken … are actually going to have, ultimately they will contribute to inflation.’

Overall, if Lagarde wanted to support the perception that a 75bp hike in December remains at least a viable option, she could only have done a better job by being more explicit than would be entirely consistent with her style or the prevailing high uncertainty.

Her emphasis on inflation’s unbroken momentum, her mention of the possibility of second-round effects on wages in the context of risks essentially all to the upside, and her repeated highlighting of interest rates as being the instrument of focus all lend support to the idea that the Eurotower may go big again.

We would find it normal as well that the ECB president already has some idea of November euro area HICP, due to be released publicly on Wednesday, and that this may be underlying her hawkish mood.

Moreover, the question arises for us of whether the ECB is preparing for a weak outcome in terms of QT at next month’s Governing Council meeting, which would be good reason to keep the option of a 75bp hike alive, as we think any deceleration of the hiking pace would need to be compensated by heightened prospects of a balance sheet reduction.

For Lagarde today, it was all about hiking. Given an opportunity to speak about QT, she was content to repeat her opening remarks on the subject, themselves not new, with barely any elaboration other than to stress, somewhat clumsily, precisely those aspects that suggest the Council would not be hitting it out of the park in December in terms of balance sheet reduction.

‘[W]e will discuss and decide the general principles that will apply to this balance sheet reduction that is part of the monetary policy normalisation that we have to undertake’, she said. ‘But I can tell you that in my view, the main characteristics of these principles will be that it should be measured and that it should be predictable. Because, you know, what has been quantitative easing over the course of time, many years, has to be then measured, because you undo what you have done at a measured pace, and it should be done in a predictable fashion.’

Beyond the talk of QT proceeding cautiously, one had to search for similarities between Lagarde’s performance today and her last monetary statement, which was clearly dovish. That fact is striking in and of itself, as elements of that statement would normally have been a convenient blueprint for such an appearance – if, of course, they still held.

But then again, perhaps they don't.