2023-06-19 18:34:39
The European Central Bank has just raised interest rates, and now the struggle is over how to proceed. ECB Chief Economist Philip Lane said on Monday a further move higher in July seemed appropriate. With a view to the upcoming September meeting, however, he did not want to commit himself. The ECB is letting the data guide its monetary policy decisions – and September is still a long way off. “September will be decided in September,” Lane said.
The governors of Slovakia and Lithuania also stated that there was no urgency to commit to a decision for the September 14 session.
ECB executive board member Isabel Schnabel, on the other hand, said in Luxembourg that the central bank cannot afford to be complacent with regard to inflation and should not currently worry that it could raise interest rates too much: “We have to remain data-dependent – and preferably too much than doing too little.”
The ECB raised interest rates by 0.25 percentage points last week. ECB President Christine Lagarde described another such hike in July as “very likely”.
ECB hawks still want rate hikes in the fall
Since then, several hawks, ie supporters of tighter monetary policy from the Governing Council, have signaled that rate hikes could continue into the autumn. Bundesbank President Joachim Nagel said on Friday that interest rates might have to be raised further “after the summer break”.
For the head of the Belgian central bank, Pierre Wunsch, the peak of the tightening cycle might not even be reached in September: “If the core rate stays at 5 percent on an annual basis in the coming months, we will continue to raise it beyond September.”
In her speech, ECB Executive Board member Schnabel paid particular attention to core inflation, which is inflation excluding energy and food. “Inflation has started to decline from historically high levels, largely due to the sharp fall in energy prices,” she said. “Underlying inflation has also moderated recently – but it has proved more stubborn than expected .” The ECB has just had to adjust its forecasts for core inflation noticeably upwards.
Workers don’t work as many hours
Schnabel named three risks why inflation could surprise to the upside. First, supply-side shocks could continue to hit the euro area, for example oil and gas could become more expensive because of the Ukraine war or the green transformation.
Second, there are dangers known as “hysteresis”: shocks that are temporary could have long-term effects on economic activity and weigh on economic supply. Hours worked per worker continued to lag behind pre-pandemic levels. As a result, despite the strong increase in employment of 3.1 percent, the total number of hours worked increased by only 1.4 percent in the same period. One reason for the sluggish recovery in average working hours is the significant increase in sick leave, as figures from Germany show.
The third risk is that one overestimates the economic slowdown and its effects. Schnabel also expressed concern that there had been changes in inflation expectations. “In the past, inflation perceptions tended to closely track actual inflation trends,” says the ECB governor. Recently, however, an unusual gap has emerged between perceived and actual inflation: “Apparently, the recent sharp fall in headline inflation has not yet had an impact on consumer perceptions, as they continue to perceive inflation as historically high.”
The observed shift in inflation expectations could reduce the strength of the transmission, i.e. impede the implementation of monetary policy.
Strong labor market a problem for the ECB
A sensitive point for the effectiveness of monetary policy is currently also the labor market. “The demand for labor is still exceptionally high,” said Schnabel. Surveys pointed to continued job growth in the coming months despite interest rate hikes.
“In other words, one of the most important channels for transmission of monetary policy – if not the most important – is currently not working as usual,” Schnabel said. Structural factors such as the increase in sick leave, the higher share of services in value creation and the lack of workers contribute to this.
A tight labor market, in turn, increases the bargaining power of workers in an environment where wages are already rising at a historically high rate: “If wages rose more than currently forecast and at the same time productivity might fall, companies would be more likely to blame the higher labor costs on the labor market turn consumer prices around.”
A comment by Christian Siedenbiedel Published/Updated: , Recommendations: 79 Christian Siedenbiedel Published/Updated: , Recommendations: 63 Christian Siedenbiedel Published/Updated: , Recommendations: 9
All this speaks for a lot of uncertainty regarding the future development of inflation. Research by the Bank for International Settlements (BIS) also showed that inflation forecast errors were highly correlated over time, Schnabel said: “In other words, the fact that we underestimated the persistence of inflation over the last year increases the likelihood that we continue to underestimate inflation today.”
Overall, Schnabel argued that it is better to do too much than too little when raising interest rates; this is easier to correct when in doubt.
#Struggle #ECB