Fed Watch: Powell Shifts Inflation Stance While ECB’s Lagarde Lags The Issue

If there was any doubt before that Christine Lagarde is out of her depth as head of the second-most important central bank in the world, the floundering at the European Central Bank (ECB) in the face of surging inflation should put it to rest.

Federal Reserve Chairman Jerome Powell has turned on a dime after maintaining for months that inflation was transitory. In congressional testimony last week, Powell acknowledged that inflation is more persistent than the Fed had anticipated and that it is time to “retire” the word “transitory.”

The ECB’s policy is not so clear. Calling the central bank’s stance on inflation disoriented, German columnist Claus Döring sharply criticized Lagarde, who came to the ECB post with no previous experience as a central banker, for being willing to speak on almost every subject except economics and the central bank’s mandate to maintain stable prices.

Lagarde “positions herself on almost all issues of the day,” Döring wrote in the daily Börsen-Zeitung.

“She speaks out in the gender debate as well as on environmental risks and climate change. This quickly gives the impression that she can do everything and nothing.”

When she does comment on the economy, as she did on Friday at a virtual event, she tends to play down inflation and the impact of the pandemic. She concluded it is “very unlikely” the ECB will raise interest rates in 2022.

ECB Political Overreach Leading To Decline?

Her attitude marks a clear decline at the ECB. The central bank’s first chief economist, Otmar Issing, said in a mid-November speech published Sunday in an abridged version that the:

“...potential overreach of central banks into areas like climate change threatens their independence as they come increasingly under political influence. It is time for central bankers to show a little more humility and think about returning to clearer and more limited mandates.”

Issing, who is currently head of a think tank in Frankfurt, doesn’t think central banks should ignore the impact of climate change but feels it is up to elected government officials to lead the fight on that front.

German central bankers have a well-deserved reputation for being somewhat rigid, and the outgoing head of the German central bank, Jens Weidmann, has been the biggest inflation hawk on the ECB’s governing council (comprised of the central bank chiefs from the eurozone’s 19 member countries as well as the six-member ECB executive board).

This can be a useful quality when inflation threatens to damage the economy. Germany’s incoming chancellor, Olaf Scholz, due to be formally elected by parliament on Wednesday, is reportedly ready to nominate a former Bundesbank executive board member, Joachim Nagel, to succeed Weidmann.

Nagel, while somewhat more pragmatic and less ideological, is sure to continue Weidmann’s hawkish stance as inflation in Germany has reached a 30-year high of 6%. It remains to be seen how influential he will be in ECB monetary policy.

New Fed Appointees Could Provide Dovish Tilt As Tightening Proceeds

Despite Powell’s turnaround on inflation, it’s still difficult to forecast the future course of the Fed. President Joe Biden has said he will announce new Fed appointments in “early December” and he is expected to nominate as many as three progressive economists to vacant or soon-to-be vacant positions on the board of governors.

This would tilt the board decidedly in a dovish direction, with greater emphasis precisely on non-monetary issues like climate change.

In the meantime, a consensus seems to be building that the Federal Open Market Committee will announce an acceleration of its reduction in bond purchases after its meeting Dec. 14-15. The committee could earmark reductions of $30 billion a month starting in January, from the $15 billion a month in November and December. This would bring an end to the previous $120 billion a month by March, and free the committee to hike interest rates if needed to curb inflation.

Powell has come under fire for his dilatory response to inflation, but he is likely to win consensus in the current FOMC for a more hawkish stance going forward.

The International Monetary Fund on Friday called for the Fed to step up its tapering operation as the multilateral lending agency sees the combination of robust economic recovery and tighter labor markets from the Omicron variant of COVID-19 as increasing inflationary pressures.

The Paris-based Organization for Economic Cooperation and Development also warned last week that inflation now poses the greatest risk to economic recovery. The main risk, the OECD wrote in its economic outlook:

“is that inflation continues to surprise on the upside, forcing the major central banks to tighten monetary policy earlier and to a greater extent than projected.”

Lagarde likes to take her cues from the Fed, so a shift toward tighter monetary policy in Washington might force the ECB to adopt a harder line on inflation.