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EDITOR IN CHIEF- ABDULLAH BIN SALIM AL SHUEILI

Christine Lagarde has a real rates problem

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LONDON: European Central Bank President Christine Lagarde is running to stand still. Her policy rate is at a record low. But the weakness of inflation means that the real rate, which is adjusted for changes in prices, is actually rising.


This may buoy the euro – the last thing that Lagarde needs.


Euro zone consumer prices fell an estimated 0.3 per cent in September from a year ago, an even bigger drop than the 0.2 per cent decline reported for August, data from the European Union statistics office showed on Friday.


Special factors including a cut in value-added tax in Germany and lower energy costs played a role.


But coronavirus-damaged economies are unlikely to generate much inflation for some time.


The euro zone is not the only place where low inflation is automatically pushing up real policy rates.


But the phenomenon is most marked on Lagarde’s turf.


It means US real rates are well below euro zone ones, even though the ECB — unlike the Federal Reserve — has lowered its key policy rates below zero.


The upshot may be a rising euro, since exchange rates are supposed to track differences in inflation-adjusted interest rates over time. A lot of other factors can upend textbook theory.


But Lagarde will have to work harder to encourage inflation if the euro appreciates, since a stronger single currency makes imported goods cheaper.


Depending on the causes, a long-lasting 5 per cent rise in a trade-weighted index of the euro’s value could lower inflation by 0.5 to 0.8 percentage points after one year, according to a European Commission document.


The commission said the single currency had appreciated by around 7.5 per cent on this basis between February and August.


The ECB does not fixate on the euro’s exchange rate or try to manage it.


But it does take into account the impact that its swings may have on inflation, which it aims to keep close to but below 2 per cent. — Reuters


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