The risk of recession has increased and the best way to fight inflation is to raise rates. This is the gist of the ECB president's speech Christine Lagarde spoke at the European Banking Congress in Frankfurt. "We have acted decisively, raising rates by 200 basis points, and we expect to raise rates further to levels necessary to ensure that inflation returns to our medium-term target of 2% in a timely manner." How fast and up to what level "will be determined by the inflation outlook."
Investors are now torn between expecting a 50bps and 75bps hike in December, following a series of 75bps hikes, and see bond holdings shrinking, also known as quantitative tightening, starting in the first half of 2023.
Lagarde: "It's time to reduce the bond portfolio"
So, further monetary policy tightening is on the way through i rate hikes. But not only. To strengthen the momentum of our interest rate policy - he added - it is appropriate that the ECB's balance sheet "be normalized in a measured and predictable manner". It means reducing the amount of securities stocks accumulated with the various anti-crisis programs of recent years, such as the quantitative easing. But he also reassured that "the tools to preserve the orderly transmission of monetary policy", in particular the flexibility on the renewals of securities in the pandemic emergency purchase program pep and the new mechanism anti-spreads (Tpi) “will remain active”.
Lagarde: "Banks must be part of the solution"
The major crises underway, from the energy crisis to that of the contraction of the global job offer, require significant investments. And to face the transition, we need a resilient financial sector. “We need that banks continue to be part of the solution. But undermining the solid foundations we have built would not help to achieve this goal – added the president of the ECB -. We are facing a rapidly changing world, characterized by multiple shocks and profound uncertainty. Against this backdrop, excessively loose regulation would leave banks more exposed to shocks and less able to sustain the transitions on which our future growth will depend. And this would be neither in the interest of the sector, which would be less profitable, nor of the economy, which would not have the funding”.
Lagarde: "Recession risk increased, but it won't significantly reduce inflation"
“Inflation in the euro area is far too high, having reached double digit in October for the first time since the start of monetary union. And with inflation likely to remain elevated for a long time, we need to monitor the evolution of inflation expectations very closely,” she said. “Furthermore, although recent GDP growth data surprised to the upside, the risk of a recession has increased. At the same time, historical experience suggests that a recession is unlikely to significantly reduce inflation, at least in the short run. Against this backdrop, showing commitment to our mandate is key to ensuring that inflation expectations remain anchored and that second-round effects do not take hold.”
Lagarde on tax policies: "They must be temporary, targeted and tailored"
The end point of the rate-hiking cycle will be determined by the inflation outlook, but Lagarde stressed that countries must "move together." In fact, the economic outlook will also depend on the alignment between monetary policy and the other actors and, in the short term, the orientation of the fiscal policy it's important. In the current environment of high inflation, fiscal policy must be temporary, targeted and tailored. It should be temporary in nature, so as not to drive up demand too much in the medium term; targeted, so that the size of the tax boost is limited and benefits those who need it most; and tailor-made, so as not to weaken the incentives to reduce energy demand”.
The reactions of the markets to Lagarde's intervention
After Christine Lagarde's words at the European banking Congress Milan continues to rise by almost one percentage point in line with the others European Stock Exchanges: Frankfurt up 1,25%, London up 1% and Paris up 1,35%. Milan 0,98% and Madrid 0,92%. Sharp rise in rates on the European government bond market after the words of the ECB Christine Lagarde: il yield of the BTP ten-year bond rises by more than ten basis points to 4,03% after two days spent below the psychological threshold of 4%. The spread with the German Bund, however, it remains stable at 194 given the simultaneous rise in the yield of the German government bond as well.
