“Disinflationary Dynamics Unlikely to Return” Says Lagarde, Rate Hike in July – Trustnodes

“Even when supply shocks fade, the disinflationary dynamics of the past decade are unlikely to return. As a result, it is appropriate for policy to return to more normal settings rather than those aimed at raising inflation from very low levels.”

So said Christine Lagarde, the President of the European Central Bank, while trying to square an inflationary environment that is not coupled with excess demand. She said:

“The euro area is clearly not facing a typical situation of excess aggregate demand or economic overheating. Both consumption and investment remain below their pre-crisis levels, and even further below their pre-crisis trends.”

In a situation where there is excess demand they would raise rates beyond what they would consider neutral, she said, but even though arguably there is a lack of a “neutral” level of demand, they will target “neutral” rates, she said.

Neutral in this case being 2% if inflation stabilizes at that level with Lagarde stating that leaving policy rates unchanged in the current environment “would constitute an easing of policy, which is not currently warranted.”

She will also be nimble like the Fed, though in this case it’s flexibility, optionality, and gradualism, as:

“Supply shocks are raising inflation and slowing growth in the near term. This means that policy normalisation has to be carefully calibrated to the conditions we face.”

The one argument she gives towards moving interests rates to probably 2% eventually, is that imports are becoming expensive:

“A large share of the inflation we are experiencing today is imported from outside the euro area. This is acting as a terms of trade ‘tax’, which reduces the total income of the economy – even if we take into account the higher prices being earned by exporters.

Cumulatively from the second quarter of 2021 to the first quarter of this year, the euro area transferred €170 billion, or 1.3% of its GDP, to the rest of the world.”

Making it a tradeoff between imports and exports, and since even Armani flip flops are made in China now, rather than in Europe, imports are bigger than exports.

This move was inevitable however as among other things commercial banks need a profit motive to lend, which 2% interest rates should provide.

Europe in addition is now seeing proper growth at 5.1% for the first quarter, compared to a claimed contraction in USA, with ECB still leaving time for the second quarter before moving towards what hopefully will be a return to a trend of some inflation with decent growth.

Unlike Jerome Powell, Fed’s chair, who arguably has been moving too fast with a contraction in the first quarter to prove it, here ECB is going at the rate we would have thought.

So the European economy shouldn’t care much and hopefully will absorb the optional gradualism, but how this transition will be managed, remains to be seen.