ECB President Signals End to Inflation Surge, But Cautions on Services and Wages

European Central Bank (ECB) President Christine Lagarde has indicated that the Eurozone is nearing the point where it can declare victory over the recent surge in inflation, but cautioned that vigilance is still needed, particularly regarding services and wage growth. In an interview with the Financial Times’ Martin Wolf on the “Economics Show” podcast, Lagarde stated that while the latest inflation reading is 2.2%, within the bank’s medium-term target of 2%, the lingering stubbornness of services inflation at 3.9% is a concern.

“I think we’re getting very close to that stage when we can declare that we have sustainably brought inflation to our medium-term 2%,” Lagarde said, adding, “I’m saying that with a little reservation because I still believe that we should be very vigilant about services." She noted that some underlying inflation figures are moving downwards, providing comfort, but emphasised the need for continued scrutiny.

Lagarde identified three key areas requiring monitoring: wages, profits, and what she termed "late-comers" in price increases. She acknowledged that a wage “catch-up” was underway in response to previous price increases, but said that the ECB's "wage tracker" – which compiles collective bargaining agreements across seven key European nations – shows wage growth is now expected to align with inflation targets.

On the topic of profits, the ECB President stated that elevated profits post-Covid are now declining, with businesses absorbing some labour cost increases rather than passing them on to consumers. This acts as a buffer to further price pressures. Lagarde also highlighted sectors like insurance as late-comers to the inflation cycle, having only recently renewed their contracts at higher rates. She expressed the hope that these sectors would not be “late-leavers” by continuing to increase prices.

When asked about the origins of the recent inflation surge, Lagarde acknowledged that while a series of global shocks—including the pandemic and the war in Ukraine—played a major role, Europe’s lack of energy diversification, particularly its dependence on Russia, exacerbated the situation. She also noted that the form of fiscal support used by European nations during the crisis, notably furlough schemes, may have been less stimulative than the US approach of direct payments, contributing to the difference in the economic recovery of the two regions.

Lagarde admitted that looking back, the ECB’s own pandemic-era monetary policy actions, including massive asset purchases and targeted long-term refinancing operations totaling over €4 trillion, were possibly excessive. While deemed necessary at the time to prevent economic collapse, they may have fueled the subsequent rise in inflation. She said that while she wouldn't pass judgement on previous decisions, she would question the volume of those initiatives now.

Despite the challenges posed by soaring inflation, Lagarde noted one significant success: the absence of a sharp rise in unemployment during the disinflation process. She attributed this to the ECB’s credibility in achieving its inflation target, which allowed wage expectations to remain anchored. The jobless rate actually hit historic lows, and the labor market remained tight. This outcome differed significantly from economists' predictions of a painful recession required to control prices.

Lagarde said a puzzle remains regarding many people's perception of income. She added that despite data showing wage growth outpacing prices, a significant portion of the population feels like their income hasn't recovered. She suggested this could be due to the time lag between price increases, which are often noticed daily, and salary rises, which are often annual and don’t necessarily register with consumers, and is a factor in unusually high savings.

Looking ahead, Lagarde said she "very much hopes" that the Eurozone will not return to an era of zero or negative interest rates. She added that the ECB is conducting monetary policy with the goal of “getting to target and then being sustainably at that target.”