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ECB must keep on raising rates to fight inflation, policymakers say

The European Central Bank must keep raising interest rates, prioritising its fight over painfully high inflation, even if that comes at a cost to growth, European Central Bank policymakers said.

The ECB raised rates by an unprecedented 75 basis points on Thursday just weeks after a 50 basis point move and promised several more steps over the coming months as euro zone inflation was at its highest rate in nearly a half a century and at risk of becoming entrenched.

“Inflation remains unacceptably high,” Peter Kazimir, Slovakia’s central bank chief said. “The priority now is to continue vigorously the normalization of monetary policy.”

Echoing his words, Dutch central bank chief Klaas Knot said that slowing growth was a necessary side effect of this inflation fight.

“We expect inflation to keep rising in the coming months, so that means we only have one problem on our plate: inflation,” Knot said in an interview with Dutch radio broadcaster BNR. “And that will mean that we will have to slow economic growth at least a bit to reduce inflation.”

While the ECB projected stagnating growth over the winter months, ECB chief Christine Lagarde acknowledged that many of the downside risks to this outlook have already materialised, particularly the loss of access to Russian gas, raising the risk of an outright recession.

Some have argued that raising rates now is futile because the inflation shock is caused by high energy prices and central banks are powerless against supply side shocks.

But French central bank chief Francois Villeroy de Galhau appeared to challenge that view, arguing that only half of the current inflation was due to food and energy prices, suggesting that price growth is now broadening out to hit all parts of the economy.

But Villeroy also seemed to push back against expectations for another extra large rate hike in October.

“We have our hands completely free. Nobody should speculate that this will be the magnitude of the next step – we did not create a new ‘jumbo habit’, he said in a speech.

Lagarde said it would take fewer than five meetings, including Thursday’s gathering, for the ECB to hit what it calls the neutral rate, where it neither stimulates nor slows growth.

That timeline suggests hikes at each meeting until early next year broadly in line with market expectations, which see the top of the cycle next spring.

While the neutral rate is not known, Villeroy upgraded his view on Friday, arguing that it was at below or close to 2%, replacing his previous estimate for somewhere between 1% and 2%.

Although big rate increases are still possible, Knot echoed Villeroy in that another 75 basis point move is not a given even if the inflation outlook remains poor.

“If the picture for inflation is still as bad in 6 weeks time, then we will make a strong move again. This doesn’t necessarily have to be 75 basis points though,” he said.

The ECB described both the July and September moves as “frontloading” and Lagarde said that 75 basis points is not the norm, though she also refused to rule out a similar step in October.
Source: Reuters

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