ECB and institutional inertia

June 8, 2022

The European Central Bank (ECB) meets on Thursday evening amid signs of a fracturing of views among the ECB Governing Council concerning the rapidity and quantum of policy rate hikes.

In an era that has been characterised by laggard central banks, the ECB is the poster child when it comes to a failure to appreciate the persistence, magnitude and momentum of inflation.

European inflation numbers are immensely troubling. The May Harmonised Consumer Price Index (HCPI) came in at 8.1 percent, four times the ECB’s 2% goal.

This is from a central bank whose mission statement asserts that “price stability is the best contribution that monetary policy can make to economic growth.”

Europe faces a circumstance where the inflation genie looks well and truly out of the bottle and with an accompanying massive squeeze on real incomes, the threat of stagflation is a clear and present danger.

All central banks are in the process of attempting to execute a high wire act: charting a path between getting inflation back toward target without tipping the economy into recession.

ECB President Christine Lagarde is channelling her famous countryman, Charles Blondin, as the ECB attempts the high wire act without a balancing pole and blindfolded.

It has demonstrated an egregious reluctance to engage in any meaningful shift in policy from “emergency” levels.

It will likely only announce the end of QE at Thursday’s meeting.

In other words at a time when most other developed country central banks have already commenced policy rate lift-off and have mostly decided that an accelerated path to neutral via policy rate increments of 50bps is the appropriate course, the ECB is still engaged in applying pandemic era “emergency” levels of monetary stimulus.

It is the case that Lagarde has recently abandoned her usual studied circumspection to foreshadow two 25bp increases in July and September. That is the meeting to follow Thursday’s one!

Even then she revealed a reluctance to acknowledge the depth of the inflation problem and continues to imply that it is more transitory in nature. Lagarde has asserted that the ECB was “facing a very different beast” to the Fed. That might be correct, but the May inflation numbers suggest that it might not be different in the way Lagarde sees it.

Indeed, Lagarde’s comments on July and September rate hikes did not seem to indicate a Damascene shift in view, but more an attempt to stave off growing calls among the ECB’s more hawkish wing and from markets to keep the option of a 50bp hike at either the July or September meetings.

Of course, Lagarde has a difficult job. The ECB is cursed with an institutional inertia that afflicts most pan-European institutions. That same institutional inertia severely constrained its ability to flexibly employ fiscal measures which might have taken some of the burden of monetary policy early in the pandemic.  Witness also, the tortuous intra-European negotiations over Russian sanctions in the wake of the Ukraine invasion.

The calls for a 50bp increase are getting louder with concerns about the path for consumer prices becoming unanchored, requiring tougher measures later on that could trigger an even more disruptive economic dislocation.

ECB meetings are about to get interesting – more interesting than usual – and Lagarde will need to harness all of her deft diplomatic skills and the authority she carries as the President to see her view prevail.

I have my doubts whether that view is the right one.

Stephen Miller is an Investment Strategy Consultant with GSFM. The views expressed are his own.

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