Previous monetary tightening is already taking effect, the ECB's chief economist tells MNI.
The European Central Bank will consider reducing its pace of rate increases at its Dec 15 meeting, but it is too early to say when its hiking cycle will pause, as policymakers weigh signs that bank lending conditions are already tightening against accelerating wage inflation, chief economist Philip Lane told MNI.
After two consecutive 75-basis-point hikes taking the deposit rate to 1.5%, a significant jump in bond yields is already feeding through to banks, Lane noted in an interview, adding that the planned reduction of the ECB’s balance sheet next year will also contribute to tightening.
“One platform for considering a very large hike, such as 75 basis points, is no longer there,” he said.
“The more you've already done on a cumulative basis, that changes the pros and cons of any given increment,” he said, “We will have to look at it in terms of the inflation outlook that we have in December and take into account that we are at a different point now, and also to recognise that there are lags in the transmission process.”
The effect of hikes already made will kick in more strongly in 2024 and 2025, he said, though he expected any eurozone recession to be “mild and short-lived”, and the rise in unemployment to be low by historical standards, with companies possibly more reluctant than in the past to let workers go. But uncertainty is “high”, and it is too early to say when the ECB will pause hiking.
“Trying to jump forward to February, to March, to May or June next year, I think it’s too early to have very strong views at this point. The logic of a pause for the ECB, we’re not at that point,” he said.
“The exact allocation [of rate hikes] across different meetings is a secondary issue. But the more we've already done, the less we need to do.”
INFLATION TO EASE
While easing energy prices and tighter financing conditions are likely to result in a “fairly large” reduction in inflation next year, fiscal deficits are also expected to be wider than foreseen in the ECB’s September projections, and wage price pressures are picking up.
“This is going to be one of the key issues we're going to watch. I don't think we're going to have a conclusive answer next year,” he said, “We do expect this kind of catch-up process to drive nominal wages higher over several years.”
Fiscal stimulus in response to the energy price crunch will also add to medium-term inflation pressures, said Lane, repeating calls for such programmes to be targeted and temporary, though he noted uncertainty about their macroeconomic impact.
“Everyone has to really look at this quite carefully, because a lot of the fiscal programmes right now are basically transfers to households or to firms, and the multiplier on transfers is lower than on government consumption or government investment,” he said. “A lot of people who receive these transfers may just save them, so it’s not clear whether it will result in the same boost to aggregate demand.”
October’s fall in U.S. inflation may show the Federal Reserve is succeeding in its own tightening cycle, which would help ease price pressures across the world and in the eurozone. But one month’s data does not constitute a trend, Lane said, noting possible negative scenarios including a longer recession and rising credit risks as central banks tighten simultaneously.
“This all goes back to why we are taking a meeting-by-meeting approach,” Lane said. “We are giving a kind of directional orientation that we have more to do. But in terms of the exact scale of what we need to do, it would be a mistake to be overly fixated in either direction.”
A roadmap to be announced in December will indicate that reinvestments from the ECB’s Asset Purchase Programme will be reduced in a “mechanical” fashion, which will also contribute to tightening.
“The roadmap will subsequently convert into a more precise plan that will allow for the asset purchase programme portfolio to decline at a certain pace in the coming months, but I don't think we're going to be on a meeting-by-meeting basis interconnecting the interest rate decision with the pace for the next month or two,” Lane said, “Of course, if you don’t scale down the APP portfolio, the policy rate would have to be higher – there is a substitution effect there.”