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This quotation attributed to former French President Jacques Chirac is a fair summary of the points made by Christine Lagarde at the meeting of the European Central Bank (ECB) held on 21st of July.
First and foremost, this is apt because of the ECB’s decision to increase its key rates by 50 basis points instead of the 25 basis points hike announced a few weeks earlier. The Frankfurt-based central bank chose quite an unusual method to prepare the market for an end to the 11-year hiatus in rate rises. Rather than paving the way with the traditional flurry of weak signals, the ECB chose to announce this first hike with precise details of the timing and extent of the move: a rise of 25 basis points on the 21st of July. But, surprise, surprise, the rise came in at 50 basis points, in a unanimous decision. It thus took the ECB just six weeks to row back on its stated intentions, muddling its guidelines. In response to an environment that is more uncertain than ever as regards inflation, weakness in economic activity, and the political and geopolitical situation, the ECB has decided to play it by ear, moving in line with future economic data and plunging markets into an even thicker fog.
New anti-fragmentation mechanism lacks clarity in its implementation
The quotation above is also appropriate regarding the expansion of the ECB’s toolkit to include an anti-fragmentation mechanism, the Transmission Protection Instrument (TPI). Under development for several months, it is aimed at avoiding the emergence of a large gap between the national interest rates of Member States. The form of the TPI was outlined only at the end of the press conference in a brief press release. This made it impossible for journalists to clarify its contents.
Does this point to a certain unease within the Governing Council, despite the mechanism having been agreed upon unanimously? Its substance is equally vague. The ECB will exercise great discretion in the use and calibration of the TPI: the key criteria for its roll-out in any given country seem to be subjective and therefore potentially flawed from a legal perspective. In addition, Italy is hurtling towards a political crisis. This will undoubtedly offer a full-scale crash test in the upcoming weeks if markets decide to step up attacks on the widening gap between Italian and German rates. At 230 basispoints it is already approaching the critical threshold.
Both, this about-turn and the vagueness are undoubtedly down to the tricky situation in which the ECB finds itself. It was slow to get to grips with prolonged inflation, then delayed taking adequate measures, and it may now be trying to make up lost ground, putting itself in a position to tackle the recession that is looking increasingly likely with each passing week. Rather than defending its credibility at all costs, it has opted for a pragmatic and reactive approach. Is it looking to be better armed for the next crisis?
Written on 22 July 22, by Olivier de Berranger, CIO, LFDE