MNI INTERVIEW: ECB Would Be "Lucky" If No More Hikes-Wieland

The European Central Bank would be lucky to avoid further tightening and may need to raise key interest rates significantly while tolerating negative growth if it is to tame inflation, former German Council of Economic Experts Chair Volker Wieland told MNI (see MNI SOURCES: ECB Mulls September Hawkish Pause, August CPI Key).

Euro area inflation has stopped increasing, but much of the decline is attributable to falling energy prices, he said, adding that the question of whether there has been a change to the so-called neutral real rate of interest at which inflation is stable was key.

“The ECB’s deposit rate stands at 3.75%, and the MRO rate at 4.25%. Given current operating procedures, the deposit is the relevant policy rate that determines money market conditions, and it remains well below core inflation,” Wieland said in an interview. “We'd have to be very lucky for that to be enough. I would feel more comfortable if (interest rates) were closer to 5% than where we are now.”

The new level of the real neutral rate is unclear, he said.

“If it is between 1% and 2% the nominal equilibrium rate would be between 3 and 4%. From this perspective, a rate of 3.75% in the euro area money markets is not particularly tight. It may well be the long-run equilibrium.”

CLEAR SIGNAL

Wieland said it was encouraging that the ECB had sent a clear signal of its commitment to bringing inflation back to 2% in March, when it hiked rates by 50 basis points despite market turmoil over the failure of some U.S. banks and forced merger between Credit Suisse and UBS.

If necessary, the ECB should be prepared to hike into a recession, he said, though he noted that at the current juncture any euro economic slowdown would not be caused by monetary policy.

“Most periods of high inflation have required a recession to get inflation back under control, but we have yet to see really binding positive real interest rates. The Fed’s message has been if we need a recession to contain inflation, so be it. That's my interpretation, at least,” said Wieland, Chair of Monetary Economics at the Institute for Monetary and Financial Stability, Frankfurt, and now co-chair of the Hesse state government’s new Economic Future Council.

WAGES WATCH

Among other factors, the ECB identified rising wages as an increasingly important driver of inflation, and Wieland said he expects further strong pay increases in Germany to be bettered by those in other member states, especially those with solid growth and tight labour markets.

“Wages are going to rise further, and we have already had pretty significant wage settlements,” he said. “Employees are not stupid. They understand that just because inflation declines, they do not regain purchasing power.”

At around 6%, declining German harmonised inflation is towards the middle of the European spectrum, Wieland noted, with measures of core inflation that strip out energy costs stuck above 5%, reflecting “across the board” domestic prices increases.

“It's totally misplaced to think this is purely a “Putin” inflation due to the energy price shock whose effects will dissipate very quickly,” he explained.

“If you look at the US, you can actually see that inflation rose well before the Russian attack on Ukraine and peaked early in 2022. In the euro area also, inflation rose to about 6% by the end of 2021. The war and energy crisis pushed it to 10% by the end of 2022.”

The early rise of inflation in 2021 had to do with the exit from the corona crisis and the long-lasting support of aggregate demand via very expansionary fiscal and monetary policies, Wieland said.