The European Central Bank (ECB) should closely monitor the upside risks to inflation, but without rushing to proceed with new moves, stresses in an interview with Bloomberg the governor of the Bank of Greece Yannis Stournaras and member of the ECB’s governing council.
The fact that secondary effects, such as wage increases, have not appeared so far is “good news”, however it is not certain that this will continue, he adds.
“We are seeing a continuous sequence of disruptions on the supply side and we cannot simply ignore them. At the same time, there is also a strong factor on the demand side, due to fiscal expansion and the boom in investments in artificial intelligence”, he notes from Dublin, where he is participating in a meeting of European finance ministers and central bankers. “We must remain vigilant”.
Monetary policy officials, who have raised borrowing costs twice since the outbreak of the war with Iran, are now considering what additional measures are needed to bring inflation back to the 2% target, from above 3% today.
Some believe that the unexpectedly resilient course of the Eurozone economy leaves room for new interest rate increases. Others, however, worry that the economy will not withstand a much greater tightening of monetary policy.
Marginal rise in Eurozone consumers’ inflation expectations
With more than a month remaining until the ECB’s next decision, Mr. Stournaras indicated that he has not yet settled on the stance he will take, according to Bloomberg. As he said, the ECB’s new economic forecasts will be a significant guide for the decision.
“If there is a flare-up in inflation in September or an increase in energy costs that leads us deep into the adverse scenario, an interest rate increase in October cannot be ruled out”, he said. “But if there is even some doubt, we will do nothing and wait for the next round of forecasts. There is no reason to rush”.
As oil and natural gas prices rise again, ECB President Christine Lagarde stressed that increases in energy prices do not necessarily imply higher interest rates as well. Nevertheless, other members of the governing council who spoke to Bloomberg in Dublin left open the possibility of further increases.
Markets are largely pricing in a third increase of 25 basis points in the deposit rate next month, to 2,75%. They then expect at least two more increases before inflation is brought under control, although economists appear less certain that monetary policy will need to reach this level of tightening.
Mr. Stournaras warned that the environment remains volatile.
“If the economic data show that the resilience of the economy is weakening or that growth is slowing, I believe that would be a reason not to raise interest rates and to pause”, he said. “Also, if there is an agreement in the Middle East, it could once again lead to a very rapid de-escalation in energy prices”.
Mr. Stournaras also stressed that the interest rate increase by the Federal Reserve this week also works supportively for the ECB. “The Fed’s decision on interest rates was positive for its credibility and for the credibility of monetary policy globally, because of the central role played by the Fed and the dollar”.
The discussion about the ECB’s next steps is taking place in an environment of rising yields on government bonds in the Eurozone. On Friday, the risk premium on French bonds exceeded one percentage point for the first time in 14 years, as investors are increasingly concerned about the country’s large fiscal deficit and political uncertainty.
For Mr. Stournaras, the situation remains under control, although, as he noted, political developments will play an important role in its course.
“So far at least, we have not seen any major turmoil”, he said. “I hope governments will continue to be aware of the need for fiscal prudence, given our previous experience with policies that were not sufficiently cautious”.