NFollowing last year’s spike in inflation, inflationary pressure in the European Monetary Union is slowly beginning to ease, according to ECB chief economist Philip Lane. The European Central Bank’s (ECB) hefty rate hikes are beginning to take effect, Lane said in an interview with Reuters news agency published on Tuesday.
“For energy, food and goods, there are many forward-looking indicators that show inflationary pressures are likely to come down fairly significantly in all of these categories,” he said. “We also received confirmation that our monetary policy is working.”
In the fight against high inflation, the ECB implemented the interest rate turnaround in July 2022 and has since raised the key rates five times at a rapid pace by a total of 3.0 percentage points. The deposit rate, which is decisive on the financial markets and which financial institutions receive from the central bank for parking excess funds, is now 2.50 percent. For the next interest rate meeting in March, ECB President Christine Lagarde has already announced a further hike of 0.50 percentage points.
Two percent inflation target
According to Lane, the price-dampening effect of the tightening stance will increase over time. “Every month, every quarter, more and more people are exposed to the new interest rate environment and so is the impact of monetary policy,” Lane said. So far, only a minority of companies and households are fully exposed to interest rate hikes. “So the second half of this year will be very important because it will be a full year since we started raising rates,” he said. The ECB is aiming for two percent inflation for the euro zone – but it is still a long way from that.
According to Lane, the ECB will not move away from its tightening stance until it is confident that inflation will return to the central bank’s 2% target. The chief economist named three criteria that must be met for the central bank to stop raising interest rates. “One element is our inflation projections, and here I mean the whole path, not just the end point,” he said.
To do this, progress in lowering core inflation, which excludes volatile energy and food prices, would need to be visible in the data. And thirdly, it must be assessed how powerful and fast the central bank’s tightening course is having an effect.
maintain interest rates for some time
The ECB plans to leave rates there for a period of time once interest rates have reached a plateau, Lane said. In his view, they could be held at so-called restrictive levels for a number of quarters. Economists understand this to mean an interest rate level that slows down the economy. The financial market is currently betting that the ECB could raise the deposit rate to almost 4.0 percent by the end of the year. This is partly due to fears that core inflation could remain at an excessively high level for a long time. In January, this measure of inflation rose to 5.3 percent from 5.2 percent in December, while the general inflation rate in the euro area fell to 8.6 percent from 9.2 percent in December.
According to Lane, it’s not just energy prices that are behind the recent fall in inflation. He referred to positive developments in the early stages of pricing. The price pressure on services is also easing. Airlines, for example, could now plan capacities better again. “Thus, the supply-side component of inflation in services should weaken,” he explained. However, an important issue to monitor is the development of wages, since many services are very labour-intensive.
The ECB will publish new inflation and economic forecasts at its next interest rate meeting on March 16th. Lane suggested that inflation projections could then come in slightly lower. He referred to falling oil and gas prices, the easing of supply bottlenecks and the reopening of the Chinese economy. The interest rate hikes by the ECB would also have to be recalculated.
The tightening turned out to be significantly stronger than was contained in the December forecast. Lane has no doubts about the prospect of a 0.50 percentage point rate hike in March. In his view, the arguments for such a step are still solid.