the president Lagarde promoted by the markets- Corriere.it

Until a couple of months ago the markets seemed to have antennas only for the restrictive messages of the central banks, even if they themselves expected a severe recession in Europe and perhaps also in the United States. Now the balance has reversed. A long and deep economic downturn seems far less likely, yet markets only have antennae for more dovish signals from central bankers. So in 2022 the prices of stocks and bonds collapsed with the announcements of the European Central Bank. Yesterday, 2 February, the opposite happened: the ECB raised rates by 0.50% to bring those on deposits to 2.5%; and Christine Lagarde explained that she will continue to raise them even after next month because we still have some way to go to bring inflation back to 2%.

And yet, as if the president of the ECB had announced the end of the squeeze, the financial markets celebrated. Yields on ten-year Italian government bonds, which move inversely to prices, fell by 0.39%. The spread on the equivalent German bonds narrowed by 18 points to 182. The euro lost 0.71% against the dollar. And all the European stock exchanges grew: the Ftse Mib of Milan increased by 1.5%, the Dax of Frankfurt by 2.16% (both back to their highest levels for a year), the Cac40 of Paris increased by 1.26% (well above the levels of a year ago).

It was a passage from Lagarde’s message that restored confidence, and the coming months will tell if it is excessive. The ECB and its president have insisted that monetary policy must be and remain restrictive – that is, such as to hold back the economy – and have confirmed their intention to raise rates by another 0.5% next month. For the sequel to the ECB this time he did not tie his hands, as he had done last December. In the future, our rate decisions will be driven by data, Lagarde said, and will be defined from time to time at each meeting.

Many in the market have read, at least, the beginning of the end of the squeeze that began last July. Various factors can make this believe. Overall inflation remains high but, thanks also to the rapid drop in gas prices, falls faster than expected and was 8.5% in the euro area in January (10.6% in October). Above all, traders continue to see the ECB as essentially trailing the Federal Reserve and in lockstep with the Bank of England. On Wednesday, the US central bank had slowed the pace of increases with a 0.25% adjustment, hinting at a pause in the coming months. Yesterday the Bank of England raised rates to 4%, but hinted that for now it could be in its final tweaks. Even the Bank of Canada has said it is halting interest rate hikes for now.

The climate among governors around the world is changing. For all this, the markets only wanted to hear the good news from the ECB, as in December they only heard the bad ones. The reality could be more nuanced and the reaction of the traders could have been, once again, excessive. Seldom entirely mistress of clear communication, yesterday Lagarde hinted at underlying inflation that she — she reminded her — she didn’t budge. Indeed, the core index, excluding the volatile energy and food prices, remains unchanged at 5.2%. It seems likely that a majority among the 26 central bankers on the Governing Council would like to see a somewhat persistent decline in that underlying inflation before taking their foot off the brakes on the European economy. It is therefore possible that two more rate hikes of 0.25% each will arrive in May and June, before a break. On those there could be a clash in the ECB. But it will be nothing compared to what Lagarde expects if and when inflation has come down a lot, but struggling to get back to 2%. By then, in about a year’s time, the ECB will have to choose whether to let go or continue to compress a euro area economy of over 11 trillion euros under its pressure for a long time.