Lagarde and Weidmann agree on how to respond to rising inflation

The head of Germany’s central bank has put a stop to the eurozone’s monetary policy by warning that inflation is likely to remain above the European Central Bank’s target for longer than expected and may require a reduction in its stimulus.

Jens Weidmann, the outgoing President of the Bundesbank and a member of the Governing Council of the ECB, told a banking conference in Frankfurt on Friday: “Given the considerable uncertainty about the inflation outlook, monetary policy should not commit to its current very expansionary stance for too long.”

His comments coincided with those of Christine Lagarde a few hours earlier, when the ECB president told the same event that interest rates should remain “patient” to avoid tightening policy too soon, despite rising eurozone inflation, which is “unwelcome and painful”.

“We must not rush into premature tightening when faced with transient or supply-driven inflation shocks,” Lagarde said, indicating that she expects the ECB to maintain a significant stimulus at its meeting next month, although others central banks reduce support.

Their speeches revealed divisions among ECB interest rates ahead of their meeting next month, where they will have to decide how many bonds to buy next year and publish new inflation forecasts that will give investors a crucial clue as to how close they are to raising interest rates. .

The ECB is increasingly different from other major central banks, such as the US Federal Reserve and the Bank of England, which have responded to the recent rise in inflation by promising to tighten policy.

Christine Lagarde, President of the European Central Bank, told a banking conference in Germany: “We must not rush into a premature tightening when faced with temporary or supply-driven inflation shocks” © Kai Pfaffenbach / Reuters

Inflation in the euro area hit its highest level in 13 years at 4.1 per cent. in October, well above the ECB’s target of 2%, prompting some investors to bet that the ECB would raise interest rates next year. But Lagarde said many of the driving forces behind higher inflation, such as soaring energy prices and supply chain bottlenecks, “are likely to fade in the medium term,” meaning that the conditions for raising interest rates are very unlikely to be met next year. “.

“At a time when purchasing power is already under pressure from higher energy and fuel bills, an unnecessary tightening would represent an unwarranted headwind for recovery,” she added.

Lagarde’s remarks knocked the euro, which was already hit by investors’ concerns about restrictions to counter registered Covid-19 infections in parts of Europe. The euro fell 0.7 percent against the US dollar to trade at $ 1,284, close to a low of 16 months, and lost ground against other major currencies, including the pound and the yen. Against the Swiss franc, it hit a six-year low of SFr1,048.

Eurozone government bonds rose against the backdrop of the prospect of the ECB’s policy remaining accommodative for a longer period of time, and were given a further boost by news of new German and Austrian restrictions being implemented to curb the spread of coronavirus. Yields on German 10-year government bonds, a benchmark for eurozone-wide assets, fell 0.04 percentage points to minus 0.32%, the lowest level in two months.

“The market is understandably afraid of further Covid-related disruptions and the impact that may have on growth,” said Lee Hardman, a currency analyst at MUFG. “It certainly helps Lagarde’s efforts to push back expectations of early ECB rate hikes.”

The head of the Bundesbank expressed doubts about the ECB’s predictions that inflation will fall below its target of 2%. in the next few years. “Increased inflation rates are likely to take longer than previously expected to fall again,” said Weidmann, who announced last month that he would resign in December, six years before his term expires, in part because of his frustration with ECB policy. .

“To keep inflation expectations firmly rooted, we need to repeat over and over again: if necessary to ensure price stability, monetary policy as a whole will need to be normalized,” he said.

When the ECB meets next month, it is widely expected to announce that its 1.85 tonne bond buying program expires in March 2022. Investors expect the central bank to mitigate the potential impact on bond markets by increasing its longer-term active purchasing program.

After committing to not raising interest rates before stopping the purchase of primary bonds, next month’s decision will send an important signal about the potential time for the first rise in interest rates.

Weidmann pointed out that the ECB had become the largest creditor to eurozone governments after buying government debt worth almost a third of the bloc’s gross domestic product. “Central banks will increasingly come under pressure from governments and financial markets to keep monetary policy expansionary for longer than the rationale for price stability would require,” he said.

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