ECB’s Lagarde bets that rates held at record high will curb inflation

FRANKFURT (Reuters) – The European Central Bank’s record high deposit rate could help cut inflation to 2%, ECB President Christine Lagarde said on Monday, repeating the bank’s guidance that neither promises nor rules out further rate hikes.

Policymakers have provided different interpretations of this guidance over the past week, with one extreme arguing that the next move is likely to be a rate cut while the other side saying that the chance of another hike could be close to 50%.

“We consider that our policy rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to our target,” Lagarde said.

But Lagarde highlighted some modest softening in an otherwise resilient labour market, which is set to help disinflation after rapid nominal wage growth kept pressure on prices.

“The labour market is finally adjusting and will probably take a little bit more time to adjust,” she told European Parliament’s Committee on Economic and Monetary Affairs. “Job creation in the services sector is moderating and overall momentum is slowing.”

Markets see no further rate hikes on the premise that concerns over an economic slowdown will become a bigger worry than inflation. Investors also see a small chance of a rate cut by next June and see a cut almost fully priced in by July.

“Recent indicators point to further weakness in the third quarter,” Lagarde added.

Speaking about an ongoing review of the ECB’s operational framework for steering short-term interest, Lagarde said that the conclusion of the exercise would be delayed until next spring from the end of this year.

The ECB launched the review last December, partly to reduce the 3.7 trillion euro excess liquidity sloshing around in the bank sector, but disagreements over a host of technical issues already pointed to a delay.

This large pile of excess liquidity is leading to large losses for the euro zone’s central banks given that interest rates are now record high and some may even require recapitalisation from the government, a politically contentious issue.

“Eurosystem staff is analysing the optimal long-run size and composition of our balance sheet – and by implication, the adequate level of excess liquidity,” Lagarde said about the review. “This is not a trivial issue as it has implications for the way we implement monetary policy.”

(Reporting by Balazs Koranyi; Editing by Alison Williams)