Could underlying inflation rise as energy prices fall? ECB’s Lane flags the risk

The prospect of falling headline inflation alongside rising underlying inflation was highlighted by European Central Bank (ECB) Chief Economist Philip Lane at the Bank of England and its Watchers Conference. If energy prices ease, “headline inflation could fall while underlying inflation rises,” he said, adding that “it would be a surprise if there are no second-round effects,” in his remarks.

On policy communication, Lane said he would set a “high bar on directional forward guidance now.” He also stressed that the ECB places a “very high premium on consensus” within the Governing Council.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

What were Lane’s main points?

Consensus is a very high priority for us; achieving it would be difficult with dots

For now, I would set a high threshold for directional forward guidance

The ECB needs an instrument to address multiple equilibria in the bond market

The lack of movement in underlying inflation so far is informative: it reflects the usual delayed response

Inflation 1-year ahead can be gauged from underlying inflation

The reversal in energy prices is already under way; a continuation could bring headline inflation down even as underlying inflation climbs

An absence of second-round effects would be surprising

How Is the Euro Performing Today?

The Euro’s strongest performance today was against the Australian Dollar. Its percentage changes against the major currencies listed are set out in the table below.

	USD	EUR	GBP	JPY	CAD	AUD	NZD	CHF
USD		0.53%	0.75%	0.56%	0.50%	0.89%	0.53%	0.74%
EUR	-0.53%		0.21%	0.02%	-0.02%	0.36%	0.02%	0.21%
GBP	-0.75%	-0.21%		-0.19%	-0.21%	0.14%	-0.22%	-0.00%
JPY	-0.56%	-0.02%	0.19%		-0.04%	0.34%	-0.02%	0.19%
CAD	-0.50%	0.02%	0.21%	0.04%		0.38%	0.02%	0.23%
AUD	-0.89%	-0.36%	-0.14%	-0.34%	-0.38%		-0.36%	-0.15%
NZD	-0.53%	-0.02%	0.22%	0.02%	-0.02%	0.36%		0.20%
CHF	-0.74%	-0.21%	0.00%	-0.19%	-0.23%	0.15%	-0.20%

To read the heat map of percentage changes between major currencies, select the base currency in the left-hand column and the quote currency in the top row. Selecting the Euro on the left and following that row across to the US Dollar, for instance, gives the percentage change for EUR (base)/USD (quote) in the corresponding cell.

ECB: Frequently Asked Questions

How does the ECB operate, and what does it mean for the Euro?

Based in Frankfurt, Germany, the European Central Bank (ECB) serves as the Eurozone’s reserve bank, determining interest rates and overseeing the region’s monetary policy. Maintaining price stability is the ECB’s main mandate, with inflation kept at around 2%. Changes in interest rates are its principal means of pursuing that goal. Higher rates, relative to those elsewhere, generally strengthen the Euro; lower rates tend to have the opposite effect. Monetary policy is decided by the ECB Governing Council, which meets eight times a year. The decision-makers comprise the heads of Eurozone national banks and six permanent members, among them ECB President Christine Lagarde.

How does Quantitative Easing (QE) work, and why can it weaken the Euro?

When conditions are extreme, the European Central Bank can turn to Quantitative Easing. Under QE, the ECB prints Euros to purchase assets, generally government or corporate bonds, from banks and other financial institutions. The Euro typically weakens as a result. This policy is a last resort when interest rate cuts alone are unlikely to deliver price stability. The ECB deployed QE during the Great Financial Crisis in 2009-11, again in 2015 as inflation stayed persistently low, and during the COVID pandemic.

How does Quantitative tightening (QT) work, and why can it support the Euro?

Once an economic recovery is under way and inflation begins to climb, QE can be followed by its reverse, Quantitative tightening (QT). Under QE, the European Central Bank (ECB) supplies liquidity to financial institutions by purchasing government and corporate bonds. With QT, it instead halts further bond purchases and no longer reinvests principal repaid as bonds in its existing portfolio mature. The effect on the Euro is generally positive, or bullish.