Powell: Time to retire temporarily

Christine Lagarde (R), President of the European Central Bank (ECB), and Vice-President Luis de Guindos (L)

Thomas Lohnes | Getty Images News | Getty pictures

Federal Reserve Chairman Jerome Powell surprised market participants earlier this week when he changed the tone of inflation. Now economists in Europe say that the European Central Bank must do the same.

Powell told U.S. lawmakers that “it̵[ads1]7;s probably a good time to withdraw that word (temporarily) and try to explain more clearly what we mean” when talking about inflation.

Rising consumer prices have been a matter of growing concern for the financial markets. Inflation has reached levels above the central banks’ targets, and money managers are skeptical about whether simple monetary policy is the right approach. This is no exception in the euro area.

“Transitory suggests we do not have to worry about it. But we do not know if we should worry about it,” George Buckley, chief economist in the UK and the eurozone in Nomura, told CNBC on Wednesday.

He suggested that it was still unclear whether higher inflation in the eurozone would have a more permanent effect on the economy.

Data released on Tuesday showed that inflation reached a historic high in the 19-member bloc of 4.9% in November. The ECB’s policy is to work towards 2% inflation in the medium term.

So far, the central bank has said that it expects inflation to fall through 2022 – indicating that there is still a need for a relatively loose monetary policy. But there are growing questions about whether this period of high inflation will last longer than the ECB expected.

The ECB predicted in September that inflation would reach 2.2% by the end of the year; 1.7% in 2022 and 1.5% in 2023. These estimates will soon be revised.

Higher energy prices, ongoing supply chain problems and, more recently, the emergence of a new Covid-19 variant may increase inflation expectations.

Nomuras Buckley said that the longer high inflation persists, the more markets will feel that central banks need to do something about it. This is because higher inflation increases the pressure for a tighter monetary policy.

Calls for clearer messages

“The ECB does not need to withdraw” temporarily “, but should communicate in a more nuanced way about short-term one-off factors and potential long-term factors that push up inflation,” said Carsten Brzeski, global macro chief for ING Research.

He added that the ECB should acknowledge that it has been too naive when it comes to breakthroughs from producer prices to consumer prices, and should therefore be careful to appear convinced of other traditional conditions.

The question of clearer messages has been raised before.

In the wake of the ECB’s last meeting in October, Nick Andrews, European analyst at Gavekal Research, said that President Christine Lagarde “failed miserably” to throw cold water over market expectations of a 2022 rate hike.

“By the end of Wednesday, the short-term fixed income market had priced in an increase of 23 basis points by December 2022. At the end of Lagarde’s press conference on Thursday, it priced in an increase of 32 basis points,” he said in an email.

Going forward, ECB observers expect the central bank to continue to emphasize that inflation will decline next year.

“I still expect the ECB to signal that inflation is expected to ‘decline’ in 2022, but also to emphasize the upside risk of the inflation outlook,” Frederik Ducrozet, strategist at Pictet Wealth Management, said via email.

He added that the institution could note that “inflation will not go down as fast and as much as expected.”

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