The ECB's Challenging Trinity
This week has been a big one for the ECB, as global policy makers are gathered in Sintra Portugal for the annual ECB Forum. The theme that dominates this year’s conference is not only the need for ECB interest rate hikes, but what this rate hiking cycle looks like in the context of issues that are specifically EU related.
As Lagarde said in her introductory speech to the conference yesterday, there are two issues that make the ECB hiking cycle different than most of the challenges that other developed market central banks are currently facing.
Excess inflation is largely a byproduct of Europe’s lack of energy resiliency in the face of an energy price shock. While domestic demand has been strong, services recovering and investment picking up, EU output is still below its pre covid trend. This is of course different to the Anglo economies that likely overheated in a much more traditional sense, I.e. excess demand.
The second factor is the unevenness of policy transmission in a currency union. Lagarde presented the challenge best yesterday: “the euro area has a unique institutional set-up, built around 19 not yet fully integrated national financial markets and 19 national fiscal policies, with limited coordination. This presents the risk of our monetary policy stance being unevenly transmitted across the union.”
This sets up a very challenging backdrop for the ECB, especially as these goals have become somewhat divergent.