ECB’s Lagarde makes premature summer cut forecasts and puts central bank's credibility at risk

ECB President Christine Lagarde has once again given indications on the timing of rate interventions, signalling a 'likely' cut in the summer. Thus Lagarde does not respect the 'data dependency' that the central bank says it wants to follow. In a very uncertain environment, the ECB board formally decided to abandon forward guidance on rates. Instead, Frankfurt has made it clear that every move must be guided by economic developments (hence the 'data dependency'). But in fact the opposite is often the case. ECB officials announce moves without knowing how the inflation outlook will evolve.

Lagarde goes off the rails on rates

Today no one can predict what the March and June ECB projections will say. Yet Lagarde has already indicated a rate cut in the summer. By violating data dependency, the ECB is tying its hands instead of remaining flexible. If the economy does not move as expected, Frankfurt risks losing credibility or having to pursue a strategy that is no longer correct. It has happened before that the ECB has found itself in this cage.

At this stage, the primary goal of Lagarde and other board governors is to move market expectations on the first cut further ahead. Prior to the speeches by the president and other ECB officials, the markets had predicted a rate cut in March because they had observed the strong disinflation taking place and the growing risks for the European economy, which is getting closer to recession. The markets thus showed that they were more 'data-dependent' than the ECB.

The uncertainty of the macro scenario

It is impossible to know now whether in the end traders will be right to be more optimistic about inflation and more pessimistic about growth. But that is the point: only the forthcoming economic data will be able to tell. Committing in advance may be counterproductive. Bank of Italy governor Fabio Panetta did not make any predictions in his speech to the Abi executive committee. "It would be inappropriate and institutionally incorrect," he said. Panetta urged to look at the upcoming data, recalling the risks and uncertainty rising in the economic scenario.

In particular, it is not possible to predict at the moment whether and what impact the events in the Middle East will have on inflation. Similarly, the development of wages, energy prices, government measures and the transmission of monetary policy through credit is unknown. The extent of the economic slowdown and possible recession also remains to be seen. Depending on these variables there could be a rise in inflation or a fall well below the 2% target (BofA sees inflation at 1.4% next year). Despite all this, some central bankers are already telling the markets the timing of the rate cut.

Joachim Nagel, president of the Bundesbank, said that the discussion on the cut should start 'in the summer break'. Other governors, including Lithuania's Simkus and Slovenia's Vasle, ruled out a cut in the second quarter. But above all Lagarde, responding in Davos to a question about a majority of central bankers who would like a cut in the summer, said: 'It is likely but I have to be reserved because we are data-dependent'. If she really was, Lagarde would have avoided any indication.

The risks of the ECB communication

Markets and analysts moved accordingly: 'When the ECB president says something like that, it's like a pre-commitment,' noted Ing. Some economists note that a cut would be appropriate in March, but the hawkish bias will push the ECB to delay the move at least until June, even at the cost of putting an unnecessary burden on the economy. While waiting to see how the macro data will evolve, the ECB communication appears contradictory and risks complicating the achievement of the inflation target.