In the run-up to the European Central Bank’s (ECB’s) record three-quarter-point rate hike in September, which had been expected and priced in by the markets, there were dissenting voices.
Several members of the bank’s 25-person Governing Council advocated a more moderate 0.5 percentage point move, fearing that the front-loading of rate hikes could push the euro zone’s already ailing economy into a sharper and more painful recession than is necessary. ECB chief economist Philip Lane has long favoured a more gradual approach.
This time around, there were no dissenting voices.
Announcing another 0.75 percentage point rate hike — an increment that would have been inconceivable a year ago — and flagging the likelihood of further increases in the coming months, the ECB said: “Inflation remains far too high and will stay above the target for an extended period.”
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Inflation in the euro area rose in September to 9.9 per cent, up from 9.1 per cent in August, well above the ECB’s 2 per cent annual price stability target. Food price inflation surged to 13.8 per cent, the highest on record.
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Risks to the growth outlook are “clearly on the downside”, ECB chief Christine Lagarde said, highlighting higher loan costs for consumers and businesses, alongside dwindling confidence. The opposite is true of inflation, she said.
Surging energy and food prices combined with the increased borrowing costs are creating a perfect storm for households.
The latest interest rate increase means that someone on a tracker mortgage here who has €200,000 remaining on their loan will now be paying around €180 extra each month compared to the start of the year, which equates to an additional €2,160 over 12 months.
Inflation can’t stay high for long before workers start demanding higher wages to compensate. Rising wages eventually have to be passed back to the consumer in the form of higher prices, fuelling further inflation, potentially creating a dangerous spiral at the heart of the economy.
We’re not there yet but the fear is that inflation is becoming entrenched in areas beyond the energy sector and this fear seems to be trumping the recessionary implications of higher interest rates.
Added complications for the ECB flow from the fiscal policies of various member states. Big moves to shore up household budgets here and in Germany combined with energy price freezes in France work in the opposite direction, undermining the dampening effects of higher interest rates.
The ECB has warned that fiscal policy must not work at odds with monetary policy. The UK’s recent financial turmoil and the Bank of England’s intervention can be seen as an example of this clash.
Lagarde again noted that the bank has dropped its policy of forward guidance on interest rates in the face of such price uncertainty, adding that speculation about where the euro zone’s neutral rate (where this sequence of rate hikes might end) was “not necessarily helpful”.
“We have acknowledged more rate (hikes) are in the pipeline but at which pace and to which level I cannot tell you,” she said.
