Lagarde: The ECB must not react to the current rise in inflation

European Central Bank President Christine Lagarde said on Friday that inflation in the eurozone would weaken, so the ECB should not tighten policy as it could stifle the recovery and hinted that bond purchases would continue next year.

Eurozone inflation hit 4.1% in October, driven by higher energy costs and is expected to stay above the ECB ‘s target of 2% next year, as suppliers suffering from the pandemic are unable to keep up with opening up the economy.

But Lagarde insisted the ECB should not brake now and continue to add fuel to the economic recovery.

“When inflationary pressures are expected to weaken – as they do today – it makes no sense to react with a tougher policy,” he said. “The tightening will not affect the economy until the shock has already passed.”

The ECB is due to decide on the future of bond-buying programs at its policy meeting on 16 December.

While the central bank has already signaled that the € 1.85 trillion Pandemic Emergency Purchase Program (PEPP) will expire in March, Lagarde said asset purchases will continue to be “significant” after that date.

“Even after the expected end of the pandemic emergency, it will continue to be important for monetary policy – including the proper calibration of asset markets – to support the recovery and sustainable return of inflation to our 2% target.” he said.

The Bank of England is expected to raise interest rates widely later this year and the Federal Reserve is ending its bond-buying program.

But Lagarde argued that tightening the policy would now squeeze household incomes, which are already facing a shock from rising energy costs that are likely to limit growth.

“In this situation, tighter monetary policy will only worsen the contractionary effect on the economy,” he said.

While Lagarde acknowledged that the outlook for inflation had improved after a decade of sluggish price growth, she said the ECB should “supply” demand.

“As positive demand forces in the economy strengthen, the outlook for inflation in the medium term looks better than before the pandemic,” Lagarde said. “So we must continue to cultivate these forces, not withdraw political support prematurely.”