A year ago, the European Central Bank struggled to explain why it wasn’t raising interest rates despite rising inflation. This year will have an equally difficult task to explain why it keeps increasing them, even as the price index drops rapidly.
Inflation, already two percentage points below its peak, will fall rapidly as energy prices fall, and the bank will cut its forecast next month on lower gas prices and a rebound in the value of the euro .
However, the ECB has already promised another steep rate hike in March and bank officials are also signaling a move in May, driving up mortgage costs, hampering business investment and increasing public debt burdens as consumers feel the first drop in prices in a year.
The problem is that the outlook for inflation is not as good as it first appears.
Underlying price pressures show little sign of abating, and while the general population knows little about core inflation – which filters out volatile food and fuel prices – policymakers are focusing on this number because it is an indicator of the duration of the price growth.
“We will keep rates high until we see concrete evidence that underlying inflation returns to our target in a timely and lasting manner,” said ECB board member Isabel Schnabel recently, repeating the bank’s recent mantra on core inflation.
At some point during the Northern Hemisphere summer, headline inflation, now at 8.5%, could fall below the base rate and could even remain below 3% by the end of the year. year, as energy costs fall below current pre-war levels and become deflationary. But core inflation is proving persistent and could still rise from last month’s 5.2%.
“We have to keep emphasizing that we have this medium-term outlook,” said Klaas Knot, head of the Dutch central bank. “And having a medium-term perspective means it’s clear that underlying inflation is relevant to policy.”
The problem is not unique to the euro area. Federal Reserve officials also expect US inflation to fall below core this year and are particularly concerned that rising utility prices could make it difficult for inflation to return to the 2% target.
But communicating it to the public is difficult. The ECB is expected to target 2% inflation in line with its target and has already been criticized by investors for sending mixed messages.
It has fluctuated between a focus on current inflation, future inflation and core inflation. It has also moved between providing monetary policy guidance and applying a meeting-by-meeting approach.
However, its main inflation problem is why Irish central bank chief Gabriel Makhlouf, a moderate on the rate-setting committee, recently said the ECB’s 2.5% deposit rate could even exceed the 3.5%, above the current market price for the maximum rate.
If inflation indeed proves to be as persistent as some fear, the ECB will face the problem of a “high sacrifice rate,” Croatia’s central bank chief Boris Vujcic warns. In such a situation, the economic loss associated with lower inflation increases and the pain associated with each increase increases.
COMPLICATIONS
Core inflation is expected to decrease, but could still remain at an elevated level.
The big question is the job market.
Even as companies braced for an almost certain recession, they continued to hire at a rapid pace and pushed employment to a record high in the recent quarter, hoarding workforces after struggling to re-hire in the months following the pandemic.
This will put pressure on wages, which are already expected to rise more than 5% this year, the fastest pace in years.
“Pressure from workers to regain lost purchasing power could be significant, especially as upcoming wage talks take place against a backdrop of a tight labor market,” Spanish central bank governor Pablo Hernández de Cos said.
Source: Terra
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