Lagarde signals ‘mild’ recession would not stop ECB from raising rates

Christine Lagarde has indicated a recession in the eurozone would not be enough to stop the European Central Bank raising rates further, underlining policymakers’ determination to quash inflation despite the risks to growth.

Lagarde said in Latvia on Thursday that a “mild recession” in the eurozone would not be enough to “tame inflation” on its own. A recession was not yet her baseline scenario for the 19-country single currency bloc, but if it happened it would not be sufficient for the ECB to “just let it roll out” to bring inflation down to its 2 per cent target.

The hawkish comments by the ECB president follow remarks after the central bank’s policy vote last week, which investors initially interpreted as a signal that policymakers could soon stop raising rates due to growing recession fears.

They come hours after the US Federal Reserve dashed market expectations that it would soon pivot towards a less aggressive monetary policy stance.

Both central banks raised rates by 75 basis points at their previous policy meetings. While the ECB and the Fed are expected to slow the pace of rate rises, both central banks have signalled they may lift rates higher than investors anticipated.

The ECB has increased its deposit rate from minus 0.5 per cent to 1.5 per cent in the past four months and is expected to announce another rise to at least 2 per cent in December to tackle inflation, which hit a new eurozone record high of 10.7 per cent in October.

The debate between ECB rate-setters is intensifying ahead of December’s meeting. Some are pushing for it to maintain the pace of rate rises to ensure inflation does not spiral out of control, while others warn it risks overshooting the amount of monetary tightening needed.

Fabio Panetta, an ECB executive board member, warned in a speech on Thursday: “When calibrating our stance, we need to pay close attention to ensuring that we do not amplify the risk of a protracted recession or trigger market dislocation.” 

He said residential property markets and non-bank financial institutions were among those areas “vulnerable to adverse loops, with falling prices and rising rates feeding into higher debt refinancing costs, especially as falling real incomes make those costs less affordable”.

The euro fell 0.8 per cent to $0.974 against the dollar on Thursday while German 10-year bond yields rose 11bp to 2.25 per cent.

A weaker euro increases inflation in the eurozone by pushing up the price of imports. Lagarde said the ECB would be “influenced by the consequences” of the Fed’s action, but it did not need to “progress at the same pace or under the same diagnosis of our economies”.

The ECB is seen as unlikely to raise rates as high as the Fed, which is now expected to raise them as high as 5 per cent next year.

Eurozone inflation has been higher than in the US for several months, however. Piet Haines Christiansen, chief strategist at Danske Bank, said higher energy prices in the eurozone meant the ECB was likely to “have a much harder time tackling this than the Fed”.

Lagarde said the US economy had much stronger demand and an “extremely tight labour market” compared with the eurozone, where there is one unemployed person for every 0.3 job vacancies, unlike the US that has double the number of vacancies than jobless people.

Eurozone unemployment continued to fall in September, dropping below 11mn people for the first time and taking the region’s jobless rate to a new low of 6.6 per cent, according to data published by the European Commission’s statistics arm on Thursday.

The euro area economy has been more resilient than expected — growing 0.2 per cent between the second and third quarters — despite an energy crisis triggered by a sharp drop in Russian gas supplies following Moscow’s invasion of Ukraine.

Norway’s central bank, however, said there were signs of an economic slowdown and a potential easing of inflationary pressure due to falling energy and freight prices as it eased the pace of its interest rate increases to 0.25 percentage points on Thursday — becoming the latest to do so after Australia and Canada.

Additional reporting by Richard Milne in Oslo