Christine Lagarde said the European Central Bank would act in “a determined and sustained manner” to tackle record inflation in the eurozone, especially if there were signs of price expectations rising sharply among consumers and businesses.
“Inflation in the euro area is undesirably high and it is projected to stay that way for some time to come,” the ECB president told its annual forum in Sintra, Portugal, on Tuesday, in a hardening of her comments on price growth. “This is a great challenge for our monetary policy.”
“Inflation pressures are broadening and intensifying”, Lagarde added. Eurozone wage growth is expected to double to 4 per cent this year, she said, adding that supply bottlenecks were likely to be persistent and there was no sign of an end to high energy and commodity prices caused by Russia’s invasion of Ukraine.
The ECB is planning to start raising rates in July, for the first time since 2011, and Lagarde on Tuesday stuck to its plan to begin with a quarter percentage point increase before a bigger move in September unless there is a rapid improvement in the inflation outlook. The bank will also stop buying more bonds next week in response to record annual inflation in the eurozone of 8.1 per cent in May, quadruple the ECB’s 2 per cent target.
While most western central banks have already started raising rates, the ECB’s benchmark deposit rate remains at minus 0.5 per cent, though it has said it expects this to rise above zero in September.
Lagarde said the ECB needed to act “in a determined and sustained manner, incorporating our principles of gradualism and optionality” — a shift from her previous comments which had put more emphasis on a commitment to only raise rates “gradually”.
There were “clearly conditions in which gradualism would not be appropriate”, said the ECB president. These included a “de-anchoring” of inflation expectations or “a more permanent loss of economic potential that limits resource availability” — such as one caused by a cut-off of Russian energy supplies to Europe — and would require it “to withdraw accommodation more promptly to stamp out the risk of a self-fulfilling spiral”.
Eurozone rate-setters face a difficult balancing act between reversing almost a decade of ultra-loose monetary policy to tackle soaring prices while trying to avoid another debt crisis in Europe after borrowing costs rose sharply in weaker countries such as Italy.
Earlier this month, the ECB called an emergency meeting to announce it was speeding up work on a new instrument to tackle fragmentation in the region’s bond markets as it tried to prevent borrowing costs from rising so high that they risked triggering a financial crisis.
Without giving new details of the planned new instrument, Lagarde said it would “have to be effective while being proportionate and containing sufficient safeguards to preserve the impetus of member states towards a sound fiscal policy”.
She said a new “anti-fragmentation” bond-buying tool could be designed in a way to keep it separate from its other monetary policy instruments and to avoid one interfering with the other. “There is no trade-off between launching this new tool and adopting the necessary policy stance to stabilise inflation at our target. In fact, one enables the other,” she said.
Economists are concerned that rising interest rates could tip the eurozone economy into a painful period of stagflation, especially if Russia continues to squeeze its supply of natural gas to Europe and forces governments to ration energy supplies for industry.
Lagarde said the erosion of households’ spending power by high inflation could hit demand and “test the resilience of the labour market and possibly temper the expected rise in labour income”.
But she added that although the ECB had downgraded its growth forecasts earlier this month, it still expected “positive growth rates due to the domestic buffers against the loss of growth momentum”.
