FRANKFURT — While European consumers fret over rising prices and economists debate the reality of a low-growth, high-inflation horror scenario, the European Central Bank’s message has stayed consistent: Keep calm and carry on.
ECB President Christine Lagarde and her colleagues are adamant current price spikes, which drove eurozone inflation to its highest level in 13 years in September, are just temporary.
Many analysts also agree these price hikes will largely wash out. But some warn the ECB is so fixated on avoiding the mistakes of the last eurozone crisis — namely by prematurely tightening monetary policy and stalling the recovery — it risks reacting too slowly to curb rising inflationary pressures.
A growing group of critics includes the heads some leading consumer goods companies, who fear higher prices are here to stay. Unilever finance chief Graeme Pitkethly recently warned inflation could continue to rise next year, forcing the company to adjust prices accordingly. Nestlé, meanwhile, cautioned it sees higher input costs pushing prices up next year.
Consumers and businesses are already feeling the pinch of inflation on the back of higher commodity prices and supply-side bottlenecks as the global economy recovers from the pandemic recession. In some eurozone member states, pressures have been particularly pronounced. In Germany, for example, inflation has reached the highest level since 1993 — and sub-components such as producer prices and wholesale prices have posted the sharpest annual increase since the 1970s.
Both sides of the debate will get more data to chew on later this week. German inflation data for October will be released Thursday after the ECB’s policy announcement, before Lagarde’s press conference that afternoon. Eurozone inflation data for October will follow the next day.
Challenging outlook
Even though energy-price inflation in particular has become serious enough to jolt EU leaders into discussing the topic in Brussels last week, ECB policymakers continue to insist most of the increase in headline inflation comes from one-off factors. Its latest forecast sees inflation falling back below the 2 percent target in the first quarter of next year and averaging at 1.5 percent in 2023.
There’s also broad agreement among experts, including those at the International Monetary Fund and private banks, that much of the recent price spike is temporary, outside the ECB’s control and set to unwind next year in any case. However, this camp has been quicker to acknowledge the high uncertainty and upside risks to inflation projections: As French Finance Minister Bruno Le Maire stated last week: “The key question is to know whether this is a transitory inflation or not. Nobody has a response to that key question.”
Murkiness also lies in the fact that the ECB has already had to recalculate its inflation projections upward the last five consecutive times. It will likely do so again in December at the next Governing Council meeting. Taking these revisions into account, Barclays economists now see inflation dipping below 2 percent only in the third quarter of next year — well after the first quarter of the ECB’s September estimation.
ECB chief economist Philip Lane, for his part, has pushed against the idea the outlook is too cloudy to call.
“We should not be flying into a narrative … [that] uncertainty is so pervasive that we have no idea,” Lane insisted in early October. “That’s not the case. There’s very solid reason to believe that a lot of this is to do with the reopening of the economy.”
This stance is being questioned, however, by economists like Greg Fuzesi of J.P. Morgan, who argues Lane is “too dismissive of upside scenarios on inflation.”
A key sticking point is the question of duration. If the temporary spike in inflation continues, the more likely it becomes permanent, Germany’s DIW economic institute has warned. Such a trend would also upend expectations of higher inflation risk, which could spark a wage-price spiral pushing up prices more permanently.
ING economist Carsten Brzeski shares that concern, warning inflation could turn out to be “stickier” than doves are currently assuming. In addition to the possibility of higher wages, he points to signs producers are set to pass higher costs to consumers instead of squeezing profit margins.
Meanwhile top bankers, including Deutsche Bank CEO Christian Sewing and Nordea CEO Frank Vang-Jensen, have said excessively low prices are over and policymakers may have to gear up for some tightening.
Amid these rising concerns, some ECB Governing Council members are becoming more sensitive to upside inflation risks. Minutes of the last policy meeting in September show some policymakers argued inflation had been “underestimated for some time,” and the ECB’s projections were too low. Only hours after the last set of projections were released, one of its members, Martins Kazaks, told POLITICO he sees an upside risk to the forecasts.
More broadly, the underlying stance of the ECB has been to discount those concerns. Lagarde didn’t mention any such upside risk during her press conference in September. And since then, Lane has argued current energy price spikes may push down, rather than lift, prices in the medium run if they substantially weigh on growth.
That stance was reinforced most recently by Italian Central Bank Governor Ignazio Visco, who stated he sees no signs of inflation becoming entrenched despite acknowledging these pressures could last “well into the next year.” His Finnish colleague Olli Rehn has been similarly sanguine, stressing “the ECB leans on the side of not overreacting” to inflationary pressures in any case. In August, he told POLITICO the ECB must avoid rushing into premature tightening once again.
Blast from the past?
As some economists see it, the ECB’s response may be hamstrung from trying to fight the last war — and it doesn’t want to repeat prior mistakes. In two crucial episodes, it hiked rates too quickly: First before the global financial crisis in 2008 and then before the sovereign debt crisis in 2011. It then had to reverse course just months later, and since then has kept its monetary policy exceptionally loose.
The easy stance of recent years marks a historic shift of sorts given the ECB had been a bastion of hawkish monetary policy among advanced economies before then. That tradition was closely tied to its chief model and neighbor in Frankfurt, Germany’s Bundesbank, which earned its hawkish chops in the 1970s when Germany was one of the few advanced economies to keep inflation in check. Some market watchers argue that legacy from the Bundesbank may have pushed the ECB to neglect the risks of too-low inflation more recently.
Now, they say, the ECB might have the opposite problem: It’s so hell-bent on avoiding another bout of premature tightening that it’s more likely to ignore above-target inflation.
“ECB policymakers are definitely fixated on not repeating mistakes from the past,” said Berenberg chief economist Holger Schmieding. “That might lead them to react a bit slower. I expect the reluctant reaction of the ECB to lead to a moderate inflation overshoot in 2024 and 2025.”
Charles Goodhart, a former Bank of England rate setter, has also weighed in. In a piece on Monday, he noted “most mainstream economists remain in denial that it could become a more persistent feature of future years and decades.”
Given such risks, central banks should think about exit plans to avoid sudden reversals that could severely harm economies, Goodhart concluded.
Then there’s the Bundesbank’s outgoing representative on the ECB’s Governing Council, Jens Weidmann, who made clear he’s at odds with the relaxed view on emerging inflationary risks at the ECB. An increasingly lonely hawk, he announced his departure last week by dropping a warning to his colleagues “not to lose sight of prospective inflationary dangers.”
For now, such warnings are seemingly falling on deaf ears in Frankfurt.
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