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EU vs. US inflation: differences warrant 'particular type of response' – ECB's Lagarde

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(Kitco News) There are stark differences between inflation in the U.S. and the EU, according to central bank policymakers, with European Central Bank President Christine Lagarde and Federal Reserve Chair Jerome Powell weighing in on the issue.

Inflation in the EU is more energy-driven than in the U.S., Lagarde said during the IMF and the World Bank spring meeting last week.

"Our economies are moving at a different pace and our inflation is fed by different components," she said during a panel discussion. "And as a result of that, our analysis of the roots and the consequences of inflation has to be different."

In the EU, annual inflation accelerated to 7.4% in March — marking a record high — and it is likely to worsen before it gets better, Lagarde noted. But the ECB cannot move at the same pace as the Fed, which is dealing with inflation at an 8.5%, a 41-year high, because the euro zone's inflation is comprised of different components.

"When you try to understand what comprises that very high number, you see that almost 50% of it is energy prices. That is a supply shock. If I look at my core inflation (if you take out food and energy), I am down to 2.9%. It is north of my 2% target, but it is more manageable. Our inflation is fuelled by a supply shock, which calls for a particular type of response, which brings together fiscal policies and monetary policy," she explained.

Lagarde was responding to why the ECB was not as hawkish as the Fed when it comes to battling hot inflation numbers.

"We cannot operate at the same pace with the same sequence, using the same instrument necessarily when it's that kind of inflation that we are dealing with … It needs to be addressed in a sequential, flexible, gradual way, which is what we have begun doing," Lagarde added.

Powell seemed to agree with Lagarde, noting that inflation was a global problem, but there were key differences from region to region. Fed Chair pointed out that the U.S. had robust economic growth and higher core inflation than Europe.

"Europe has struggled more with low inflation at a much lower policy rate than we have. We have a different level of underlying inflation," he said.

Because of this, the central bank will have to be much more aggressive very quickly, Powell added.

"In the U.S., we have had expectations that inflation would peak around this time and would come down over the course of next year. These expectations have been disappointed in the past, and so now we want to see actual progress," he said. "It may be that the actual peak was in March, but we don't know that, and we won't count on that. We are also not going to count on help from supply-side healing. We are going to be raising rates and getting expeditiously to levels that are more neutral that actually tighten policy."

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Powell also signaled the likelihood of two or more 50 basis point rate hikes at the upcoming FOMC meeting. After his comments, markets started to price in half-point increases in May, June, and possibly July.

The ECB, on the other hand, has been reluctant to increase the speed of its normalization process after it left interest rates unchanged at the April meeting and reiterated its plan to end its asset purchase programme sometime in the third quarter. 

"Flexibility has served us well in the last two years," Lagarde said. "We have a sequence that we will continue to follow."

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