“Whip effect” drives prices: Lagarde rejects interest rate turnaround

“Whip Effect” drives up prices
Lagarde rejects a turnaround in interest rates

Prices are rising, but the European Central Bank still does not want to raise interest rates. President Lagarde expects inflation to continue to rise. But in the medium term, inflation will fall again.

The European Central Bank will not allow itself to be urged by the sharp rise in inflation rates to exit the policy of cheap money more quickly. “We do not take this phase of higher inflation lightly,” said ECB boss Christine Lagarde during a banking congress in Frankfurt.

However, the central bank should “not go over to premature tightening of monetary policy in view of temporary or supply-related inflation shocks,” said Lagarde. “At a time when purchasing power is already being diminished by higher energy and fuel costs, an inadequate tightening would mean an unjustified headwind for the upswing.”

The inflation rates have been climbing for months. In Germany, for example, consumer prices in October were 4.5 percent above the level of the same month last year. Inflation in Europe’s largest economy is as high as it was 28 years ago. In the euro area, too, the inflation rate of 4.1 percent in October was well above the medium-term target of 2 percent set by the ECB.

“This inflation is undesirable and painful – and there are of course concerns about how long it will last. We take these concerns very seriously and are carefully monitoring developments,” said Lagarde. “In particular, we recognize that higher inflation is depressing people’s real incomes, especially those at the lower end of the income distribution.”

“Exceptional Circumstances”

Lagarde, however, reiterated the central bank’s view that a large part of the surge in inflation can be explained by special factors that should gradually weaken again over the next year. The monetary authorities name, for example, the recovery in oil prices after the corona shock and delivery bottlenecks as a result of increased demand. In addition, the withdrawal of the temporary VAT cut is having an impact in Germany.

According to Lagarde, the ECB will continue to support the economy even after the acute pandemic has ended. This also applies with a view to the “appropriate adjustment” of the bond purchases operated by the ECB, said the Frenchwoman. “We will announce our intentions in December,” she added. Lagarde once again clearly rejected a turnaround in interest rates in the coming year, despite the current rise in inflation.

Many economists and bankers warn against underestimating the current inflation trend. Some accuse the ECB of using cheap money to fuel inflation, which it actually wants to keep in check.

“We are determined to ensure that inflation stabilizes at our target of 2 percent in the medium term,” emphasized Lagarde. “Today inflation is largely driven high by the extraordinary circumstances created by the pandemic.” Monetary policy must therefore “remain patient and persistent,” said the ECB President.

Companies order eagerly

The ECB President pointed out that the inflation rate was only 0.3 percent in 2020, which automatically leads to higher inflation this year. But more important are those factors that have to do with the restart of the economy after the pandemic: energy prices and imbalances between supply and demand.

According to Lagarde, the rise in energy prices in October by 23.7 percent for the year contributed 2.2 percentage points to the overall inflation rate of 4.1 percent in the euro zone. “This increase is related to economic recovery and global demand recovery, as well as other special factors,” said Lagarde. These included restrictions on oil supply by the Organization of Petroleum Exporting Countries and its allies (OPEC +), sluggish US shale oil production and lower gas exports from Norway and Russia.

Another factor driving inflation was the shift in consumption from services to manufactured goods, according to Lagarde. On the supply side, manufacturers are confronted with acute bottlenecks in important goods, which would be exacerbated by the “whip effect” – a situation in which companies that are confronted with higher demand order more and earlier than normal. to ensure their own ability to deliver.

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