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Impact of rate rises on inflation to peak next year, ECB says

Higher interest rates and lower official bond purchases will only start to make significant progress in reducing eurozone inflation from this year, the European Central Bank has said, underlining why it slowed the pace of rate rises this month.

The ECB has raised interest rates by an unprecedented 3.75 percentage points since July 2022, but there is still a debate about how quickly its monetary policy tightening will bring down eurozone inflation.

In a paper published on Monday, the ECB said its efforts to push up borrowing costs, which started in December 2021 when it announced plans to stop bond purchases, had cut price growth by half a percentage point last year and predicted this would rise to about 2 percentage points over the next three years. 

“This assessment suggests that policy normalisation has exerted significant downward pressure on inflation and real GDP growth across the whole of the projection horizon,” researchers at the bank said in the paper.

“Most of the impact on inflation is expected to be seen in the period from 2023 onward, with that impact peaking in 2024,” they said, adding that economic growth would also be reduced by an average of 2 percentage points over the next three years.

The ECB researchers said there was “significant uncertainty” about the results of their model-based simulations, particularly given the recent economic shocks from the Covid-19 pandemic, Russia’s full-scale invasion of Ukraine and the record pace of its rate rises.

Eurozone inflation has fallen from a peak of 10.6 per cent in October to 7 per cent in April, but that remains in excess of the ECB’s 2 per cent target. The central bank slowed the pace of its rate increases this month, lifting its deposit rate by a quarter-percentage point to 3.25 per cent and saying it had more ground to cover.

Some of the ECB’s more dovish rate-setters have warned it should be cautious about further rate rises as the full results of these will only show up in 18 to 24 months. 

But others worry the power to bring down inflation by raising rates could be diluted by several factors. ECB president Christine Lagarde said recently that these included banks’ reluctance to pass on higher rates to savers, the build-up of excess savings during the pandemic, more government support and lower levels of variable-rate mortgages. 

The ECB analysis came as Brussels lifted its inflation predictions for this year and next, amid expectations that a robust jobs market and slightly stronger-than-expected output growth will underpin pricing pressures. 

The European Commission raised its forecast for eurozone inflation to 5.8 per cent this year and 2.8 per cent next year. That is higher than the 5.6 per cent and 2.5 per cent it previously forecast in February.

The commission lifted its growth outlook for the bloc’s economy to 1.1 per cent in 2023, marginally higher than the previous 0.9 per cent prediction, accelerating to 1.6 per cent in 2024. It said falling energy costs were likely to help the economy, pulling down companies’ production costs and household energy bills.

Nevertheless, core inflation, which excludes food and energy costs, remains “persistently high”, said Valdis Dombrovskis, executive vice-president at the commission. “To keep inflation in check, it is vital to make sure fiscal policy remains prudent, and to maintain the momentum of reforms and investments,” he added.


Source: Economy - ft.com

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