The ECB risks mistaking noise for a signal
Joachim Nagel has all but pre-announced a September rate rise. Central banks facing repeated supply shocks should follow trends, not the latest data point. A commentary by Ignazio Angeloni
It is difficult to recall, in the history of central banking, a case like the one involving Joachim Nagel, the respected president of the Bundesbank, this week. Asked by a French newspaper what the ECB’s Governing Council — which meets next Thursday and of which he is one of 27 members — might decide, he replied: “The market estimates a 95 per cent probability that we will raise rates. I would say the market knows our reaction function rather well.” Had he issued a press release announcing a rate increase, he could hardly have been more explicit.
Leaving aside the unusual decision to pre-announce a decision to be taken by a committee that he does not even chair, two questions arise.
First, is there really an urgent need for the ECB to raise rates now and, above all, to say so in advance and with such haste?
The second and more important question is this: what course should a central bank follow when it is subjected to a continuous barrage of unpredictable, uncontrollable and often illogical shocks affecting its key variables, with each change seeming to dismantle the assumptions created by the previous one?
The answer to the first question appears to be no.
In February, the European — and global — economy was hit by a sharp rise in energy prices caused by the war in Iran. There is a possibility that this could set off a generalised inflationary process.
The experience of 2022, when the invasion of Ukraine opened the way to the highest inflation in 50 years, is relevant, but it is not necessarily destined to repeat itself.
It is useful to compare today’s data with those recorded at the time. In the six months following the shock, from February to August, cumulative inflation this year was lower both in the headline price index and in the “core” index, which excludes energy and food.
It is true that energy prices rose by the same amount, with a conspicuous surge in August after the slowdown in July.
There is therefore no reason to lower our guard. On the whole, however, these figures — combined with the fact that monetary policy is now more balanced, with the ECB rate at 2.25 per cent, whereas in 2022 it was still at zero at the beginning of September — do not suggest any particular urgency.
It can reasonably be argued that the rate was already too low before the summer. The ECB’s June projections estimated that inflation would return to target only after two years, and on condition that interest rates increased.
But if that were the point, the central bank’s communication — with its mantra, repeated at every opportunity, that each meeting is considered on its own merits (“meeting by meeting”) and that decisions are based exclusively on incoming data (“data dependent”) — would be entirely misleading.
The impression is that the rush to act and communicate — Nagel’s intervention was echoed by the Irish central bank governor — reflects the agitation caused by August’s poor inflation figure and perhaps also the unexpectedly restrictive stance expressed last Friday by Federal Reserve chair Kevin Warsh at Jackson Hole. A fear of being left behind or, as the English expression has it, a “fear of missing out”? Both would be bad reasons for such a decision.
The real answer that must be given concerns the second question, and it is not an easy one. There is no single, infallible recipe, only some sound advice that can be offered.
The first piece of advice came from Warsh himself in his recent speech: never follow the latest data point, which may be inaccurate or erratic, but use all the available data and interpret the underlying trend.
This is easier said than done, but the ECB has taken a useful step in this direction with a recently published analysis that uses statistical techniques to compare the factors underlying the two experiences, in 2022 and 2026.
The result is that inflation at the time depended not only on the rise in energy prices but, crucially, also on the expansionary stance of fiscal and — as already noted — monetary policy. This is a diplomatic way of acknowledging the mistake made at the time, while also implying that the same aggravating factors are not present today.
Another sound piece of advice is, as always, to use common sense and different sources of information to confirm the plausibility of results obtained through complex methodologies.
The interpretation described above passes this test. Multiple sources of evidence confirm that macroeconomic policies were characterised by imbalances in 2022 that have now largely been overcome.
The final suggestion is that central banks should also equip themselves with simple rules and analytical tools — perhaps basic, but intuitive — alongside more sophisticated techniques, to test the “robustness” of possible monetary policy positions against changes in approach.
In a report for the European Parliament, Cinzia Alcidi and I proposed that three consecutive inflation readings that are above the target and rising over time should, in the absence of solid evidence to the contrary, provide sufficient grounds for an interest-rate adjustment.
This rule would have prevented the delay in responding to the inflation of 2021-22 and would have validated the rate increase adopted in June this year. It does not indicate the need for another increase as early as September.
A previous version of this article was published in the Italian daily MF-Milano Finanza
IEP Bocconi does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
