Senior European Central Bank policymakers have said they expect interest rates to rise beyond the point at which they constrain demand and weaken growth to bring down inflation, rebuffing criticism from eurozone politicians of moves to tighten monetary policy.
The comments from several members of the ECB’s rate-setting governing council push back against the idea it could do a “dovish pivot” and stop raising rates soon, echoing a similar message from the US Federal Reserve last week.
German central bank boss Joachim Nagel said in a speech on Tuesday that he would do all he could to ensure that the ECB would “press ahead with monetary policy normalisation with determination — even if our measures dampen economic growth”. By normalising policies, central banks aim to reach a point whereby they are neither stimulating nor restraining growth.
“In a situation where monetary policy lags behind the curve, the macroeconomic costs would be significantly higher,” said Nagel, predicting German inflation — which reached a 70-year high of 11.6 per cent in October — would remain above 7 per cent next year.
ECB vice-president Luis de Guindos said tackling inflation required rates to keep rising to tighten financing conditions. The ECB has increased its deposit rate from minus 0.5 per cent to 1.5 per cent in the past four months and is expected to announce another rise to at least 2 per cent at its next meeting in December.
“It will reduce aggregate demand, both consumption and investment,” de Guindos told Politico on Tuesday. “But it’s the only possible way forward that we have because doing nothing would be much worse.”
Next month’s decision will hinge on whether inflation continues to set new eurozone records after reaching 10.7 per cent in October — far above the ECB’s 2 per cent target.
However, European politicians have started warning the ECB not to go too far on raising rates. Last month Italy’s prime minister Giorgia Meloni said that tighter monetary policy was “considered by many to be a rash choice”, while French president Emmanuel Macron warned he worried about central banks “smashing demand” to tackle inflation.
Also last month, the ECB said “substantial progress” had been made in “withdrawing monetary policy accommodation”. The move to withdraw some policies that stimulate growth has led some investors to bet it would soon stop rate rises.
But recent data have shown eurozone inflation and growth to be stronger than expected. In the latest sign of resilience, the volume of retail sales in the bloc rose 0.4 per cent in September from the previous month, leaving them down 0.6 per cent from a year ago.
ECB president Christine Lagarde said last week that a “mild recession” in the eurozone would not be enough to “tame inflation” on its own. A recession was not yet her baseline scenario for the 19-country bloc, she said, but if it happened it would not be sufficient for the ECB to “just let it roll out” to bring inflation down to its 2 per cent target.
The ECB should stop raising rates only once underlying inflation, excluding more volatile energy and food prices, had “clearly peaked”, French central bank governor François Villeroy de Galhau told the Irish Times. This measure rose for the fourth consecutive month to 5 per cent in October.
As well as lifting rates, the ECB plans to discuss at next month’s meeting how to start shrinking its €5tn bond portfolio through a process known as “quantitative tightening” that has started at the Fed and Bank of England.
De Guindos said the ECB would start the process “sooner or later, for sure in 2023”. He added that quantitative tightening “must be implemented with a lot of prudence” and should start by “not fully reinvesting the maturing securities in our portfolio” — as the Fed is doing — rather than actively selling some bonds as the BoE has started to do.
