Financial Instability Could Reduce Need for ECB Rate Hikes, Lagarde Says
20 March 2023
By Xavier D’Arcy – FRANKFURT (Econostream) – The dampening effect of financial instability on demand could reduce the need for further policy tightening, European Central Bank President Christine Lagarde said on Monday.
Speaking at a Hearing of the Committee on Economic and Monetary Affairs of the European Parliament in Brussels, she repeated her comments from last Thursday that, if the ECB’s baseline scenario were to persist, further rate hikes would be necessary.
‘Financial stability tensions might have an impact on demand, and might actually do part of the work that would otherwise be done by monetary policy and interest rate hikes’, she said. ‘That impact is uncertain at this point in time, but it will have to be taken into account when we produce our next projections and also when we do our next assessment and decide our next monetary policy move.’
‘It cannot be [predicted] at this point in time what that next move will be, but what is certain is that we have more ground to cover on the basis of current baseline’, she told lawmakers.
If financial tensions had not dramatically increased in the runup to the ECB’s last meeting, the Governing Council would likely have issued forward guidance for further rate hikes, she said: ‘Without the aggravated uncertainty, we would have indicated that subsequent hikes would be needed, but in the face of the uncertainty that we had, it would not, and it was not the right policy indication to give, which is why we have determined that we would be data dependent.’
‘The data on the basis of which we make our decisions are haloed with uncertainty at the moment’, she said, adding that ‘we cannot possibly make a commitment on the basis of this halo of uncertainty around our projections.’
Regarding current financial tensions, she said ‘[w]e are monitoring market developments closely and stand ready to respond as necessary to preserve price stability and financial stability in the euro area.’
She also reiterated her statement from the ECB press conference last Thursday that ‘in my mind, and in the mind of the Governing Council, there is no trade-off between price stability and financial stability.’
‘Price stability is our primary objective and we know that it is conditional upon financial stability, but we are not compromising on one because of the other; We address them with different sets of tools’, she said.
The ECB would provide liquidity and develop new instruments to deal with new threats to financial stability, she said: ‘In any case, we stand ready with our policy toolkit to provide liquidity support to the euro area financial system, and if the tools that we have in the toolbox were not enough, I know that ECB staff is capable of providing the adjustment or the recalibration that would be needed in order to address any liquidity risk that we would see developing.’
The euro area banking sector was in a good position, and the ECB was ‘very confident that the capital and liquidity positions of the euro area banks are very satisfactory, with significant capital ratio and liquidity coverage ratio way in excess of requirements’, she said.
The outlook for inflation in the ECB’s latest projections did not provide enough certainty that underlying inflation was on a downward trend, in her view: ‘we see [core inflation] at 4.6% this year, declining in 2024, but only arriving at 2.2% in 2025, which is in the vicinity of our target, but it's not at target.’
‘Obviously, we have to take that into account and determine whether or not those underlying components of inflation are going to be on a declining trend or on the contrary are going to be embedded and persist, which will obviously determine our monetary policy going forward’, she said.