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ECB has started to win inflation fight – Lane

By March 2, 2023No Comments

Euro zone inflation pressures have begun to ease, including for all-important core prices, but the European Central Bank will not end rate hikes until it is confident price growth is heading back towards 2%, ECB chief economist Philip Lane said.

The ECB has raised rates by 3 percentage points since July.

It plans another half a percentage increase in March, in the hope that more expensive funding will curtail demand enough to get price growth down from levels still above 8%.

Professor Philip Lane, the former governor of the Central Bank here, said higher interest rates are working their way through the economy, weighing on the price of services and other core goods, which exclude volatile fuel and food.

“There’s significant evidence that monetary policy is kicking in,” Mr Lane told Reuters in an interview.

“For energy, food and goods, there’s a lot of forward-looking indicators saying that inflation pressures in all of those categories should come down quite a bit.”

Other policymakers, including board member Isabel Schnabel and Dutch central bank chief Klaas Knot, have expressed concern core inflation could get stuck and perpetuate inflation.

For the ECB to end rate hikes, Mr Lane outlined three criteria.

The bank needs lower inflation projections through its three-year forecasting horizon and to make progress in lowering actual underlying inflation. Finally, it needs to conclude that monetary policy is working.

“We’re all signed up to the criterion that sufficient progress in underlying inflation is important,” Mr Lane said.

Once rates plateau, the ECB plans to keep them there for some time and will not revise plans as soon as core inflation starts falling significantly, he said.

Asked how long rates could stay in a territory that restricts economic growth, Mr Lane said: “It could be quite a long-lasting period, a fair number of quarters.”

Markets expect the ECB’s 2.5% deposit rate to rise to nearly 4% by the end of the year, with the peak rate estimate increasing by around 35 basis points this month alone, mostly over fears core inflation has got stuck.

While lower fuel prices have driven a recent inflation drop, Mr Lane said a deeper look at the data suggests a more broad-based decline.

“Actual goods retail prices are still very strong, but the intermediate stage has been a good predictor of price pressures,” Mr Lane said.

“The fact that these are turning around, including through the easing of bottlenecks and global factors, suggest that there will be significant reductions in inflation rates for energy, food and goods,” he said.

Services pricing pressures are also easing as supply recovers from post-pandemic bottlenecks, making wages the issue to watch.

Airlines, hotels and restaurants are better able to plan capacity than last year, which lowers the supply side component of price pressures.

Mr Lane dismissed the idea that core inflation could move independently from overall price growth for long as workers base their wage demands on headline inflation and a lower rate there will impact incomes and thus underlying price pressures.

Price pressures have eased to the extent that Mr Lane hinted at a cut in the ECB’s own projections, due on March 16.

He pointed to lower oil and gas prices, easing of bottlenecks, China’s reopening, copious fiscal support and the ECB’s own rate hikes as factors weighing on inflation.

“The supply shocks, on net, lower inflationary pressures,” he said. “If you look further, to 2024, to 2025, the tightening of monetary policy has been significantly more than what was baked into the December forecast and that has to be factored into the new forecasts.”

None of these shocks are enough, however, for the ECB to abandon plans for a 50 basis point rate hike, Mr Lane said.

While the rate hikes could work their way through the economy more slowly than before, the impact could be more lasting since the ECB was unlikely to revert to negative rates.

The market has priced the longer-term equilibrium rate at around 2%, so 250 basis points of rate hikes are de facto permanent and will thus dampen price pressures more sustainably, Mr Lane added.

Article Source: ECB has started to win inflation fight – Lane – RTE

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