This five-letter word caused a bit of a stir this week among those who read the tea leaves in central bankers’ statements.
Christine Lagarde, president of the European Central Bank, said in a speech in Slovenia that the bank’s bond purchases under its Asset Purchase Program should be completed “by the beginning of the third quarter.”
She went on to say that this would mean a rise in interest rates “some time later.”
At the end of her Governing Council meeting in April, Madame Lagarde had stuck to the phrase that her Asset Purchase Program “should conclude in the third quarter” and that adjustments to her interest rates (yes, that means ‘increases’) “will take place some time later”.
I’ll spare you the rabbit hole of speculation about what “some time later” really means.
The good news (if you’re a borrower, maybe less so if you’re a saver…) is that Christine Lagarde also limited herself to describing any further rate hikes as a process that “will be gradual.”
Asset Purchase Program
First of all, the Asset Purchase Program, is where the ECB enters the market to buy billions of euros in bonds.
This has the effect of lowering interest rates on loans.
When it stops, the cost of borrowing in the eurozone is likely to rise.
And then there are the interest rates set by the ECB.
The slow accumulation of certainty aided by the use of the word “early” makes it now almost certain that the ECB will raise rates at its July meeting.
It also has a meeting in June, but based on the signs so far, any rate move would be a surprise.
Inflation across the euro area was estimated at 7.5% in April.
The ECB’s target rate is 2%. But he sees his target rate as something that persists in the medium term.
If that sounds a bit ambiguous and not so clear cut, then welcome to the world of central banking.
Inflation is not something static.
It’s not really a ‘something’ at all, but a barometer of thousands of purchases and transactions that take place in the economy over time.
When you fill your shopping cart, you are closing a price with hundreds of companies and the movement of those prices is what translates into inflation.
If there is a certain level of inflation in the economy, companies can expect to get more for their products in the future and will be more willing to invest in new machinery, products and jobs.
Furthermore, workers must have a reasonable expectation that their wages will increase, so they should be more happy to spend their pay packets.
All of this is in the happy world of 2% inflation.
Unfortunately, that is not the world we live in now.
And it’s not just the euro area.
Inflation in the US was 8.3% in April, with more inflation in the broader economy than in Europe, where energy prices remain the main, but no longer the only, culprit.
The Bank of England expects inflation in the UK to hit 10% by the end of this year.
All of this means that we are now at a juncture where central banks are more likely to raise interest rates rather than play with all the other levers, like bond purchases, that helped economies and governments outperform the pandemic and kept interest rates low.
The Fed and the Bank of England
Earlier this month, the US Federal Reserve raised rates by half a percent, its second rate hike this year.
Rates are now in a range of 0.75-1%.
The Bank of England raised rates 0.25% in May to 1%, its fourth rate hike since December.
There is a big debate in all three economies about whether rates should go up faster and faster and whether inflation is low or out of control.
To add to the confusion, growth is slowing.
The ECB lowered its growth forecasts for the euro area in March and could do so again when its next set of forecasts is released in June.
Just this week, the OECD released its Composite Leading Indicators, which are a mix of various statistics, from industrial production to opinion polls, meant to give an early indication of where economies are headed.
He said growth in Europe was “losing momentum.”
That could slow down inflation, since that’s what usually happens when economies slow down.
However, as we all know well now, a large part of the inflation felt in Europe is due to the prices of energy and raw materials.
And as Europe continues its efforts to move away from reliance on Russian energy and raw materials, a sizeable inflation hit is likely to come with that transition.
And it is the type of inflation that will not be dominated by interest rates.
The ECB is late to the interest rate party.
And if growth slows significantly, you’re not making up for lost time.
Let’s hope “gradual” doesn’t turn into the “grinding” we normally associate with recessions.