European Central Bank (ECB) chief economist Philip Lane is no doubt regretting the interview he gave to RTÉ in January when he made soothing noises about inflationary pressures falling this year and repeated policy then in force that official interest rates were unlikely to rise in 2022.
Little more than a month later, ECB president Christine Lagarde signalled a significant shift after the bank's governing council met during the week. The risks were now on the upside, she said, and an increase in interest rates this year was no longer ruled out.
Why the change in tone? The latest figures, published just before this week’s ECB meeting, showed euro zone inflation ticking up to a new record high of 5.1 per cent in January at a time when analysts had expected the figure to start to fall back to about 4.5 per cent.
This seems to have shifted the mood in the council, particularly as there are signs of price pressures spreading beyond energy to areas like food.
Key question
Meanwhile, the Bank of England is already increasing rates and the US Federal Reserve Board is about to start. Lagarde struck a markedly different tone in the post-meeting press conference which may be looked back on as a significant turning point.
The key question now for Lane is whether his thesis that we are seeing a “pandemic cycle of inflation” proves correct, even if the fall back to more normal levels comes a bit later than thought.
The rate of inflation could still fall back as energy prices moderate and supply chain problems ease as the year goes on. The risk is that higher inflation becomes embedded in people’s minds and feeds through to wider wage demands and prices, leading to a longer term rise in inflation.
As of now, it looks like the most we can expect this year is a nudging up of the ECB’s deposit rate from minus 0.5 per cent to about zero per cent. Interest rates will still remain very low.
But the reaction in Government bond markets this week, where there has been a significant jump in borrowing costs, shows that nerves are on edge and a lot is at stake.
