ECB faces calls to be clearer on inflation after Fed’s Powell drops ‘transitory’

Federal Reserve Chairman Jerome Powell surprised market players earlier this week when tweaking his tone about inflation. Now, economists in Europe say the European Central Bank needs to do the same.

Powell told U.S. lawmakers that “it’s probably a good time to retire that word (transitory) and try to explain more clearly what we mean” when talking about inflation.

Rising consumer prices have been a matter of growing concern for financial markets. Inflation has reached levels above central banks’ targets and money managers are skeptical about whether easy monetary policy is the right approach. This is no exception in the euro area.

“Transitory suggests we don’t need to worry about it. But we don’t know whether we should be worried about it,” George Buckley, chief U.K. and euro area economist at Nomura, told CNBC Wednesday.

He suggested that it remains unclear whether higher inflation in the euro zone will leave a more permanent mark on the economy.

Data released Tuesday showed inflation reached a historic high in the 19-member bloc at 4.9% in November. The ECB’s policy is to work towards inflation of 2% over the medium term.

So far, the central bank has said it expects inflation to come down throughout 2022 — which suggests that a relatively loose monetary policy is still needed. But, there are growing questions about whether this period of high inflation will last longer than the ECB anticipated.

The ECB forecast in September that inflation would reach 2.2% at the end of the year; 1.7% in 2022 and 1.5% in 2023. These estimates will soon be revised.

Higher energy prices, ongoing supply chain issues and, more recently, the emergence of a new Covid-19 variant could push up inflation expectations.

Nomura’s Buckley said that the longer high inflation persists, the more markets will feel that central banks need to do something about it. That’s because higher inflation increases pressure for a tighter monetary policy.

“The ECB doesn’t need to retire ‘transitory’ but should communicate in a more nuanced way about short-term one-off factors and potential longer-term factors pushing up inflation,” Carsten Brzeski, global head of macro for ING Research, said via email.

He added that the ECB should acknowledge it has been too naive when it comes to the pass-through from producer prices to consumer prices and therefore should be careful about sounding convinced about other traditional relationships.

The question of clearer messaging has been raised before.

In the wake of the ECB’s last meeting in October, Nick Andrews, Europe analyst at Gavekal Research said that President Christine Lagarde “failed dismally” in throwing cold water over market expectations of an interest rate hike in 2022.

“At Wednesday’s close, the short term interest rate market had been pricing in a hike of 23 basis points by December 2022. By the end of Lagarde’s press conference on Thursday, it was pricing in an increase of 32 basis points,” he said in an email.

Going forward, ECB watchers expect the central bank to continue to stress that inflation will ease next year.

“I still expect the ECB to signal that inflation is expected to ‘decline’ in 2022 but also to stress upside risks to the inflation outlook,” Frederik Ducrozet, strategist at Pictet Wealth Management, said via email.

He added that the institution could note that “inflation will not go down as quickly and as much as predicted.”