Maintaining the European Central Bank’s credibility is a strong argument in favor of raising interest rates next month, according to Executive Board member Yannis Stournaras.
The outlook for inflation is worsening in the absence of a peace agreement between the U.S. and Iran, while eurozone consumers will eventually begin to wonder whether policymakers mean what they say when they declare themselves ready to react, Stournaras said in Nicosia, Cyprus, where he is attending a meeting of European finance ministers.
“A rate hike has costs—for citizens, for employment—and that is why I wish we didn’t have to do it. But if the situation continues and we do not do so, this will become problematic,” said Stournaras, who is also governor of the Bank of Greece. “For the credibility of the ECB and the effectiveness of our response, we will likely need to raise interest rates in June.”
Policy makers had already discussed raising borrowing costs at their last meeting. Since then, they have made it almost clear that such a move would be inevitable if the Strait of Hormuz remains blocked, oil prices remain high, and price stability in the 21-country eurozone is threatened.
“If there is an agreement, we may see energy prices fall very, very quickly, and then interest rates may remain where they are,” Stournaras said. “But without a deal, they may move to another level, and inflation will become more intense.”
In March, the ECB projected that consumer price increases would average 2.6% this year. That forecast will likely be revised upward in June, Executive Board member Alexander De Marco said in a separate interview, also pointing to signs of weakening growth momentum.
Economic output rose by just 0.1% in the first quarter, while a survey of purchasing managers recently showed a contraction in activity.
“I have the sense that inflation is persistent, ” Stournaras said, expressing concerns that expectations could become destabilized. “The fact that the PMI is so weak won’t help us much. There are so many rigidities in the economy.”
He argued that memories of the previous inflationary shock are a burden that may force the ECB to take action.
“Everyone will wonder whether we actually have a reaction mechanism or whether it’s just a theory that’s never put into practice,” Stournaras said. “The next three weeks will be extremely critical in terms of the secondary effects.”