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“Actually, we talked about inflation, inflation, inflation”. This is how Christine Lagarde summed up discussions at the most recent meeting of the ECB. What’s more, the word inflation was used no fewer than 65 times during the press conference. However, although inflation seems to be the subject of close scrutiny in Frankfurt, we are entitled to wonder whether Ms Lagarde, who has defined herself as an owl, has turned into an ostrich. An owl is a symbol of wisdom and was intended to draw a line under the images of accommodative doves and restrictive hawks that are traditionally used to denote central bankers. Yet this press conference may indicate that, little by little, the ECB and its President are becoming trapped in an ostrich policy. Why an ostrich policy? Because the ostrich is a bird that buries its head in the sand at the first sign of danger – a symbol of the refusal to face up to reality.
Eurozone inflation has reached a level not seen in the last thirteen years. The markets’ long-term expectations measured by 5-year, 5-year forward inflation swaps are above the ECB’s target level of 2%. This is why bond markets are already anticipating a first hike in key rates by summer 2022, although the ECB is currently dismissing this assumption.
As far as consumers are concerned (and in contrast to the US), there are no eurozone surveys to provide a precise insight into households’ expectations for rising prices. But Google data illustrates the sudden popularity of this subject in its search engine across the region’s major economies. This is hardly surprising given the proliferation of headlines regarding price hikes for energy and freight, and shortages announced for the end of the year.
On the corporate side too, inflation is the major worry. This is clear from the statements issued with third quarter 2021 earnings reports. On average, inflation is mentioned three times in each corporate statement by a company in the Stoxx 600 index – the highest level since 2007.
We are therefore entitled to wonder if the ECB is not deluding itself as to the more structural nature of this inflationary surge. When all economic agents are including this new element in their economic reasoning, it is undoubtedly an indication that knock-on effects are coming into play. Investors are looking for assets capable of withstanding a period of higher inflation, such as companies that are able to increase their selling prices. Households seeing the erosion of their purchasing power will attempt to negotiate salary rises to offset this effect. And lastly, companies which have to date used the volume impact linked to the boom of reopening to absorb higher costs will surely start to pass these on in the prices of goods and services, in order to maintain or even grow their margins.
However, the ECB sees things quite differently. It still believes this spike in inflation is transitory: more persistent than it expected a few months ago, but short-lived nonetheless. There is therefore no question of the ECB reversing its forward guidance. But how long will this remain the case?
Written on 29 October 2021 by Clément Inbona Fund Manager and Olivier de Berranger, CIO