There’s a certain kind of pressure that builds in the financial corridors of Europe when central bankers don’t move at all or fast enough. The markets had been tense. It was already priced in for investors that rates would go up again before Lagarde finished her sentence. But when he spoke to a committee of the European Parliament earlier this week, the ECB president sounded more like someone who was carefully studying the weather than someone who was running for cover.
Without all the fancy words, her message was pretty simple: we see the problem, we’re responding, but we won’t go overboard.
The ECB raised rates on June 11 because inflation had gone above 3%. People began to wonder how far the bank might go just because of that. The stock market already expected between one and two more rate hikes, and the next one is likely to happen before the end of the year. Lagarde had already laid out three possible ways the bank could act based on how persistent inflation turned out to be. She confirmed on Monday that the bloc was in the middle one, which is a not-too-alarming overshoot that calls for gradual changes instead of emergency action. “The shock is too large to look through without putting our target at risk,” she told the committee. But almost at the same time, she said there was no proof yet that inflation expectations were dangerously moving away from the ECB’s 2% goal or that there were second-round wage effects that would call for a stronger response.
Take a moment to think about that difference. At the height of the inflation wave in 2021 and 2022, policymakers were most worried about second-round effects, which happen when workers demand higher wages because prices are high. This makes prices go up even more. The ECB had to raise interest rates faster than it had ever done before because of that event. Lagarde was careful to point out that things look different this time. The job market is better, people’s finances are better, and the supply chain chaos that followed the pandemic has mostly gone away. It doesn’t mean there is no risk. But the math is different.
At the moment, the ECB’s deposit rate is 2.25%. The so-called neutral range, which is the area where rates don’t help or hurt growth, is usually seen between 1.75% and 2.50%. The market seems to think that the bank will move rates toward the top of that range and then stop. Lagarde didn’t close any doors, but she also didn’t give anyone much reason to think otherwise. The bank would stay “agile,” she said, meaning it would change as new information came in. In the world of central banking right now, the word “agile” is used a lot.
One thing she talked about that doesn’t get enough attention is how wages are set. It was a quiet but important point she made: workers in Europe may be more sensitive to new price shocks because they have recently been through high inflation. That is a good reason to be worried. That’s something that people who lived through 2022 will remember for a long time. That could make the next round of wage negotiations more difficult than usual.
Lagarde also said that investments in AI are one reason why the economy hasn’t stopped growing. It’s an interesting side note to a story about inflation, but it doesn’t matter. Energy costs are still a drag on growth, but if investment in AI keeps up, it will keep growth going.
However, the truth is that no one really knows how this will end. In the same sentence, Lagarde admitted that there were risks to both growth and inflation going up. This is a polite way of saying that the ECB is trying to find its way through thick fog. Surety is what the market wants. The data doesn’t give any. For now, Lagarde seems ready to deal with the uncertainty rather than feeling pushed to act faster than is necessary.
