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European Central Bank President Christine Lagarde appeared to downplay inflation concerns today, arguing that price pressures could still subside before becoming entrenched and high energy costs would be a drag on prices further out.

Pointing to mounting inflation risks, the ECB opened the door last week to an interest rate hike later in 2022 and said that a March 10 meeting will be crucial in deciding how quickly the central bank would wind down its long-running bond-buying scheme, a cornerstone of its stimulus efforts.

But speaking to the European Parliament’s Committee on Economic and Monetary Affairs, Lagarde appeared cautious, warning that the euro zone has in the past been “particularly vulnerable” to high energy costs, which weaken household spending power and thus reduce inflation over the medium term.

“We have to bear in mind that demand conditions in the euro area do not show the same signs of overheating that can be observed in other major economies,”

“This increases the likelihood that the current price pressures will subside before becoming entrenched, enabling us to deliver on our 2% target over the medium term,” she said.

“The chances have increased that inflation will stabilize at our target. There are no signals that inflation will be persistently and significantly above our target over the medium term, which would require measurable tightening,” she added.

While Lagarde herself did not commit last week to any decision, several policymakers argued that the first move will be to speed up an exit from the bond-buying scheme, which is due to run indefinitely but at least until October.

An interest rate increase could only come thereafter but quicker tapering could mean a raise, the first since 2011, before the end of the year.

“There is a defined sequencing between the end of our net asset purchases and the lift-off date,” Lagarde said. “A rate hike will not occur before our net asset purchases finish.”

“Any adjustment to our policy will be gradual,” she added.

Markets now price around 50 basis points of rate hikes this year but economists are more cautious, with most predicting the first move either at the end of the year or early 2023.

Meanwhile, the ECB is unlikely to raise its main interest rate in July as investors are expecting, ECB policymaker Martins Kazaks said earlier.

Kazaks, who is Latvia’s central bank governor, pushed back against market bets on a July move because this would imply a complete winding down, or “tapering” of the ECB’s bond purchases before that date.

“July would imply an extremely and unlikely quick pace of tapering,” Kazaks said in an interview. “But overall, at the current juncture, naming a specific month would be much premature.”

The ECB has long said it would end its bond purchases “shortly before” raising its deposit rate from -0.5%, and Lagarde and colleagues have reaffirmed that commitment in recent days.

Asset purchases are currently set to run at least until October although sources have told Reuters the ECB is likely to bring that date forward at its March 10 meeting.

With euro zone inflation at a record 5.1% in January – more than twice the ECB’s 2% goal – Kazaks was also open to action.

“If we see that inflation remains high and the labour market remains strong or strengthens further, if we see that the economy keeps going, the direction is clear: we may act sooner than we assumed in the past,” the 48-year old economist said.

Kazaks noted that wages, a key driver of growth in prices, had surprisingly failed to pick up, but he still saw mounting risk that high inflation persisted in the euro zone, lessening the need for ECB largesse.

“With the economy recovering, inflation at this level and increased risk of persistency of inflation, new net asset purchases become less necessary,” Kazaks said.

He favoured laying out a new “roadmap” for how bond purchases would be reduced rather than setting the pace at every policy meeting, which would create “recurrent cliff effects” for the bond market.

Euro zone government bond yields rose across the board today. Italian bonds, which are highly sensitive to ECB’s purchases due the country’s high debt burden, were among the worst performers.

Kazaks singled out a potential war between Russia and Ukraine as the biggest risk to the ECB’s policy path.

“If a war breaks out, God forbid, we reassess the baseline scenario and act accordingly,” he said.

Money markets have priced in a 15 basis point rise in the ECB’s deposit rate in July, plus nearly a further 40 basis points by December.

The ECB’s deposit rate has been below 0%, meaning banks are charged to park their spare cash at the central bank overnight, since 2014.

Dutch central bank governor Klaas Knot said on Sunday he expected the first ECB rate rise to come in the fourth quarter of this year.

France’s Francois Villeroy de Galhau said on Friday that markets shouldn’t “rush to conclusions” about the timing of any ECB move, while Slovakia’s Peter Kazimir said the ECB “will be wiser in March” when it has more data.

Article Source – ECB’s Lagarde downplays inflation concerns – RTE

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