ECB brings policy a tiny bit closer to reality

The bank has therefore made the smallest possible change to its policy. In the second and third quarters, the European Central Bank (ECB) increased purchases to ensure favorable financing conditions. It therefore requires a lot of imagination to characterize the ECB's decision as a small victory for the hawks. It is nothing more than bringing ECB policy a tiny, tiny bit closer to reality. 

The reality is that the economy is recovering strongly from the corona recession. Of course, the fourth corona wave is a fact and that is a risk for growth. That wave could delay the full reopening of the economy, according to ECB President Christine Lagarde. We can also interpret that statement as meaning that the fourth wave is not yet an obstacle to full reopening. That interpretation is obvious: on the one hand because the economic damage has been lower with each new wave so far and on the other hand because we see around us that all shops are open.

Excellent growth figures
The fact that this new wave is not too bad is evident from the estimates for economic growth. They expect 5% growth this year, followed by 4,6% in 2022. Those are simply excellent growth figures. The reality is that inflation is rising and appears to be rising further. Lagarde said that monetary depreciation should fall in the course of 2022, something that is also reflected in the ECB economists' inflation estimates. They see annual inflation this year at 2,2%, before dropping to 1,7% next year and 1,5% in 2023. 

When Lagarde said that inflation should drop in the course of 2022, I had to raise my eyebrows. In the summer of this year, when prices rose noticeably, the ECB was still certain that this would happen in early 2022. This has now been postponed to sometime in 2022. That does not seem important, but it is because the ECB gives itself extra time not to change policy much and to monitor inflation developments. It also indicates that the bank is less certain that inflation will fall. I also deduce this from another subtle linguistic adjustment. 

Certainty of declining inflation is decreasing
A few months ago, the increase in inflation was almost certainly ('completely') temporary in the eyes of the ECB. In July, 'mainly' was used as a predicate and this week Lagarde spoke about how the increased inflation is 'largely' caused by temporary factors. I know that lawyers – and that is Lagarde! – by 'mainly' we mean about a 70% chance or more and use 'largely' to mean a chance of 50% or more. So here too there is a sliding scale. In other words: the ECB's degree of certainty that inflation will be temporary appears to be decreasing by the month.

I also saw confirmation of the above conclusion in the part of the press conference in which Lagarde said that underlying inflation appears to be rising. Underlying inflation is inflation without volatile energy and food prices. If you see it rising, it indicates that inflation is more broadly based than just energy prices. To say that underlying inflation is likely to rise cannot be reconciled with the recent increase in the headline figure completely fading away.  

Press accelerator
What I heard between the lines at the ECB means that the bank is increasingly less convinced that the increased inflation will return to pre-corona levels in the course of 2022. This in turn means that we must take into account that in the course of next year the ECB will have to reduce the pressure of its foot on the monetary accelerator. 

The board will meet twice more this year, in October and December. The October meeting does not seem to be important. Lagarde said the board is considering cracking some tough nuts in December. Logical, because in that month the ECB economists will also publish their inflation and growth estimates for 2024. The bank expects 1,5% inflation in 2023. If the inflation estimate for 2024 is higher, then I see the ECB's monetary policy being stronger than it is now is expected to be less generous in 2022. If the estimate for 2024 is lower, I do not rule out that the bank will stop using PEPP in 2022 (because it is a temporary emergency program, linked to the corona recession) but the regular purchase program, currently € 20 billion per month, just increasing.   

A missed opportunity
Finally, I did see a missed opportunity for the bank at the meeting. Exactly fifty years ago on Thursday, Imagine by John Lennen was published. The ECB had a great opportunity to use the notes of that as waiting music before the press conference starts instead of the very boring standard tune. It was a great occasion not only because Imagine is 50 years old, but also because it was difficult to imagine that the ECB would prove to be much less confident when it comes to inflation developments. 

Speaking of Imagine: Lennon sings 'imagine all the people, livin' life in peace'. Unfortunately, it's hard to imagine that that will ever happen. Just like all the central banks will (at least) normalize their policies in the first half of this decade.