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The ECB may have to limit growth to control inflation, says Lagarde

The ECB is dealing with both record inflation and a slowing economy, with many economists predicting a recession in the region before the end of the year.

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The European Central Bank will continue to raise interest rates and may even have to limit economic activity to tame inflation, ECB President Christine Lagarde said on Friday, singling out interest rates as the bank̵[ads1]7;s key balance sheet reduction tool.

The ECB has raised interest rates by an unprecedented 200 basis points since July to tackle inflation, saying more policy tightening would come via rate hikes and reductions in its 5 trillion euro ($5.2 trillion) debt stock.

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“We expect to raise prices further – and it may not be enough to pull in housing,” Lagarde said in a speech at a conference.

“Interest rates are, and will remain, the main tool for adjusting our policy stance,” she said. “Recognizing that interest rates remain the most effective tool for shaping our policy stance, it is appropriate that the balance be normalized in a measured and predictable manner.”

At 1.5%, the ECB’s deposit rate is not far from the so-called neutral rate, where the bank neither stimulates nor holds back growth. Most estimates for the neutral rate are between 1.5% and 2%, suggesting that the “accommodation” will have been removed after an expected increase in December.

The problem is that inflation, running at 10.6%, is well above the ECB’s 2% target and even a recession, now almost certain over the winter months, is unlikely to ease price pressures enough to let the ECB off the brakes.

Investors are now split between pricing a 50- and 75-basis-point hike in December after back-to-back moves of 75 basis points, and see the reduction in bond holdings, also known as quantitative easing, starting in the first half of 2023.

The ECB will outline plans for balance sheet reduction in December, and the process is expected to start with the bank allowing some, but not all, bonds to expire.

“The ECB will ensure that a phase of high inflation does not feed into inflation expectations, allowing excessive inflation to take hold,” Lagarde said.

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