In saying he expected the European Central Bank (ECB) to raise rates by another 0.5 per cent at its next meeting on December 15th, Central Bank governor Gabriel Makhlouf merely confirmed what most expect and what markets are pricing in. Analysts are forecasting at least another 1 per cent of rate hikes between now and March.
What’s perhaps more instructive was his comments about the rates end point, in order words when the ECB might stop increasing rates. The governor warned that it was premature to be talking about an end point for policy rates given the prevailing levels of uncertainty. “We have to be open to policy rates moving into restrictive territory for a period,” he said.
With euro zone inflation seemingly dropping – it fell from 10.6 per cent to 10 per cent between October and November, there has been speculation that the ECB may slow or even halt its schedule of rate increases.
Core inflation
However, it will be so-called core inflation that decides when the ECB stops hiking. Core inflation, which strips out energy and food prices, is at record high in the euro area at 5 per cent.
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Over 80 per cent of the items in the spending basket used to construct the price index are now showing price increases in excess of 2 per cent, up from just 20 per cent of items before the pandemic, and 50 per cent a year ago.
“As price pressures broaden across the basket, the risks of persistently high inflation becoming embedded rises and the case for tighter monetary policy becomes stronger,” Makhlouf said.
Of course, one of the difficulties faced by the ECB in its attempts to tame price growth is consumer expectations. If workers anticipate higher price growth, they’ll demand higher wages in a self-perpetuating cycle.
“If higher inflation is expected to persist, then workers will understandably look for higher wages to preserve purchasing power, and employers may in turn raise their own prices,” Makhlouf said.
So far, we’ve had a pick-up in wage growth but nothing that matches the current level of inflation. The ECB will want to ensure any sign of a wage-price spiral is avoided.
