Weidmann and Lagarde clash over how to respond to surging inflation
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The head of Germany’s central bank has set up a clash over eurozone monetary policy by warning that inflation is likely to stay 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 ECB governing council, 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 jarred with those by Christine Lagarde a few hours earlier, when the ECB president told the same event that rate-setters should remain “patient” to avoid tightening policy prematurely, despite soaring eurozone inflation that is “unwelcome and painful”. “We must not rush into a premature tightening when faced with passing or supply-driven inflation shocks,” said Lagarde, indicating she expects the ECB to maintain a sizeable stimulus at its meeting next month even as other central banks reduce support. Their speeches laid bare divisions among ECB rate-setters ahead of their meeting next month when they are due to decide how many bonds to buy next year and to publish new inflation forecasts that will give investors a crucial clue about how close they are to raising rates. The ECB is increasingly diverging from other major central banks, such as the US Federal Reserve and Bank of England, which have responded to the recent surge in inflation by promising to tighten policy.
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Inflation in the euro area hit a 13-year high of 4.1 per cent in October, well above the ECB’s 2 per cent target, prompting some investors to bet that the ECB would raise rates next year. But Lagarde said many of the drivers of higher inflation, such as soaring energy prices and supply chain bottlenecks, were “likely to fade over the medium term”, which meant “conditions to raise rates are very unlikely to be satisfied next year”. “At a time when purchasing power is already being squeezed by higher energy and fuel bills, an undue tightening would represent an unwarranted headwind for the recovery,” she added. Lagarde’s remarks knocked the euro, which was already being hit by investor concerns about restrictions to counter record Covid-19 infections in parts of Europe. The euro fell 0.7 per cent against the US dollar to trade at $1.284, close to a 16-month low, and lost ground against other major currencies including sterling and the yen. Against the Swiss franc it hit a six-year low of SFr1.048. Eurozone government bonds rallied on the prospect of ECB policy staying accommodative for longer, and were given a further boost by news of fresh German and Austrian restrictions being implemented to contain the spread of coronavirus. The yields on German 10-year government bonds, a benchmark for assets across the euro area, fell 0.04 of a percentage point to minus 0.32 per cent, the lowest level in two months. “The market is understandably fearful of further Covid-related disruptions and the impact that could have on growth,” said Lee Hardman, a currency analyst at MUFG. “That certainly helps Lagarde’s efforts to push back on expectations for early ECB rate hikes.”
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The Bundesbank boss expressed doubt about ECB predictions for inflation to fall back below its 2 per cent target in the next couple of years. “The elevated inflation rates will probably take longer than previously projected to recede again,” said Weidmann, who last month announced he would step down in December, six years before his term expires, in part due to his frustration over ECB policy. “To keep inflation expectations well anchored, we need to reiterate over and over again: if required to safeguard price stability, monetary policy as a whole will have to be normalised,” he said. When the ECB meets next month it is widely expected to announce that its flagship €1.85tn bond-buying programme will expire in March 2022. Investors are expecting the central bank to cushion the potential impact on bond markets by stepping up its longer-standing asset purchase programme. Having committed not to raise rates before it stops primary bond purchases, next month’s decision will provide a vital signal on the potential timing of the first rate rise. Weidmann pointed out that the ECB had become the biggest creditor to eurozone governments after buying sovereign debt worth almost a third of the bloc’s gross domestic product. “Central banks will come increasingly under pressure from governments and financial markets to keep monetary policy expansionary for longer than the rationale of price stability would call for,” he said.
