ECB may have to cool growth to contain inflation, says Lagarde

The European Central Bank (ECB) may need to raise interest rates so much that they will end up dampening growth as it fights high inflation, while any drain on the ECB’s bond portfolio must be “calculated and predictable”, said the president of the ECB. bank, Christine Lagarde, this Friday (18).

The ECB raised interest rates by an unprecedented 200 basis points since July and signaled further tightening of monetary policy through new hikes, a reduction in its €5 trillion debt portfolio and more expensive bank financing.

“We expect to raise rates further – and withdrawing the accommodation may not be enough,” Lagarde said in a speech at a conference.

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

The statements suggest the eurozone central bank intends to passively reduce its €3.3 trillion Asset Purchase Program, mainly government debt, by putting it on autopilot rather than using it to actively manage policy. ECB currency.

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

The problem is that inflation, at 10.6%, is far above the ECB’s 2% target and even a recession, now almost certain in the winter months, is unlikely to ease price pressures enough to allow the ECB to slow down your grip pace.

Investors are now split on whether to price in a 50 or 75 basis point rise in the ECB rate in December, after back-to-back 75-point hikes. They see the reduction – known as quantitative tightening – of their holdings in bonds, mostly issued by eurozone governments, 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, bond holdings to expire.