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European Central Bank policymakers agreed to keep the option open of another interest rate rise, even if it was not part of their “baseline scenario”, when they met last month.
Stressing the need to be “both persistent and vigilant”, ECB governing council members meeting in Athens a month ago recognised they had “to avoid an unwarranted loosening of financial conditions”, according to the official account of the decision published on Thursday.
Since that gathering, when the ECB ended an unprecedented 10 consecutive rate increases, several council members have declared that they will need to keep borrowing costs high for a prolonged period to bring inflation down to their 2 per cent target. They have said the “last mile” will be the hardest.
ECB president Christine Lagarde warned this week that it was too early to “start declaring victory” in the fight against inflation, calling for rate-setters — and markets — to “allow some time” to see how fast disinflationary forces take effect.
However, with eurozone inflation falling rapidly from its peak of 10.6 per cent a year ago, and expected to hit 2.6 per cent in November when that figure is released next week, investors are increasingly betting against the ECB raising its benchmark rate from its current level of 4 per cent.
Instead markets are pricing in a rising chance of a cut in borrowing costs by June.
The risk — most clearly expressed by Belgian central bank governor Pierre Wunsch on Thursday — is that the more investors bet on an early rate cut, the more it loosens financial conditions, which may keep inflation high and force the ECB to do the opposite.
Wunsch, one of the more hawkish members of the council, said in an interview with German newspaper Börsen-Zeitung that markets pricing in 1 percentage point of cuts by the ECB next year were “very optimistic and it even increases the likelihood that we will have to raise interest rates further”.
German central bank president Joachim Nagel became the latest ECB rate-setter to say that while inflation has been falling rapidly, this was not expected to continue.
“For some months to come, the road ahead will probably be a bumpy one with many ups and downs,” the Bundesbank president said in a speech on Thursday. “Our job is not done yet.”
He cited IMF research on past episodes of high inflation that found some countries had “celebrated prematurely”, warning this was a “clear and present danger” for the eurozone.
The account of the ECB’s last meeting showed that most council members thought they had done enough to tame inflation in the next couple of years.
“Most indicators of underlying inflation appeared to have passed their peak and continued to decline, a signal for which the governing council had been waiting for months,” it said.
Policymakers agreed they should still be ready “for further rate hikes if necessary, even if this was not part of the current baseline scenario”, it said.
However, some rate-setters pointed out that “domestic inflation was stubbornly high and longer-run inflation projections still seemed to be above the governing council’s target”.
There were also warnings that Israel’s war with Hamas meant “risks to energy prices were skewed to the upside”. Any increase could have a knock-on effect on inflation by intensifying calls by workers for higher pay “with a large number of wage agreements being negotiated at the start of the coming year”.
Source: Economy - ft.com
