Panicked ECB Fights to Regain Control of Markets

As guardians of price and financial market stability, the last word central bankers want to be associated with is “panic”.

Yet that is precisely the term used by two of the world’s leading observers. European Central Bank (ECB) to describe the message transmitted by the president of the entity, Christine Lagard, since opening the door to a 2022 interest rate hike to curb record inflation.

Investors interpreted Lagarde’s words – which were unexpected as she had previously effectively ruled out a rate hike this year – as a sign that the ECB would tighten monetary policy shortly, sending borrowing costs higher. soar in the 19 countries of the euro area.

Government bond yields have maintained their gains despite Lagarde later trying to clarify and soften their meaning.

“There can be only one conclusion: the communication task has failed. This is ‘from patience to panic,’” Carsten Brzeski, an economist at ING, said on Twitter.

Brzeski drew a contrast to Lagarde’s predecessor, Mario Draghi, who in 2012 famously quelled speculation of a euro breakup with a few words: “whatever it takes.”

“Comparing this to the Draghi era, it is extremely difficult for the market to know who to listen to,” added Brzeski.

Investors’ faith in a central bank’s communication is arguably their most valuable asset when it comes to managing market expectations, something all central bankers, including Draghi, have struggled with.

But a costly lapse at the start of the coronavirus pandemic – when Lagarde said the ECB was not around to close spreads on troubled countries’ bonds – has seen it face heightened market scrutiny.

His challenge is compounded by the vagaries of a pandemic economy and his desire to maintain a public consensus among the ECB’s monetary policymakers.

Some sources have told Reuters that a sizable minority of policymakers, who are aggressive on inflation, wanted to start easing stimulus at Thursday’s meeting.

“Lagarde panicked and went hawkish to avoid a return to the Draghi era of public dissent (especially from Germany),” UniCredit chief economic adviser Erik F. Nielsen said in a research note. “If the institution is led by a president who oscillates between sides, it is difficult to give a coherent message.”

disconnection

Following Lagarde’s press conference on Thursday, investors advanced their expectations for when the ECB will end its bond-buying program and raise interest rates for the first time since July 2011.

Analysts expect the former to happen well before the end of the year and money markets have priced in the ECB deposit rate to return to zero in December from -0.5% currently.

This is the biggest disconnect between market expectations and official ECB guidance, which sees rates remain at their current low or even cut, since they were introduced in 2013.

The rapid change in expectations prompted another ECB observer, Pictet economist Frederik Ducrozet, to ask on Twitter if Lagarde would be forced to give a rectification interview, as she did in March 2020 after her comments unsettled markets. of bonds.

Lagarde said in the European Parliament on Monday that there was no sign that a “measurable tightening” of monetary policy was necessary, a speech that Paul Donovan, chief economist at UBS Global Wealth Management, described as “accompanied by loud splashing sounds as politics inexpertly backed down.”

But Lagarde’s message has so far failed to calm market nerves, a problem especially for Italy and Greece, which have relied on ECB bond purchases to keep their funding costs in check during the coronavirus pandemic.

Ten-year Italian government bond yields have jumped from 1.4% to 1.8% in a matter of days and Greece’s from 1.8% to 2.5%, while risk premiums on these countries’ debt compared to the ultra insurance from Germany have increased

Assurances from Lagarde that the ECB has plenty of tools to keep spreads in check, including reinvesting proceeds from maturing bonds as part of its QE program, have also failed to reassure investors.

“Spreads widened dramatically because if we don’t have QE, what are the tools?” UniCredit’s Nielsen said. “We only have investments, but if that’s enough, no one seems to believe it.”

Even former ECB Vice President Vitor Constancio made a rare criticism of the change in stance after two record inflation readings, comparing his monetary policy to “looking out the window”, a quote from US economist Alan Blinder.

“Central banks must look to the future and, therefore, must use models and projections, adding, of course, some criteria,” tweeted Constancio.

“Looking out the window, seeing the temperature and deciding, is a very bad strategy for monetary policy,” he said.