ECB will maintain high interest rates

The European Central Bank must continue to pursue high interest rates in order to prevent a wage price spiral.

This was the key message from the President of the ECB Christine Lagarde who warned at the institution’s annual conference ECB Forum in Sintra this week that the rising cost of labour could keep inflation high for ‘several years’.
Lagarde said that the Eurozone had been hit by “overlapping inflationary shocks since the end of the pandemic”. By raising its benchmark interest rate from -0.5% last year to 3.5% this month she said the ECB had made significant progress in addressing high inflation but we “cannot declare victory yet”.
Lagarde said the initial phase of inflation, in which the cost of supply shocks in energy and other commodity markets was passed on to consumers by companies, was fading. But a second phase driven by rising labour costs had emerged, with eurozone wages forecast to climb 14 per cent by 2025.
Uncertainty over how these factors would influence prices was likely to prevent the ECB from knowing when borrowing costs would peak, through it has said that a further quarter-point rise is very likely in July.
“Under these conditions it is unlikely that in the near future the central bank will be able to state with full confidence that peak rates have been reached”, Lagarde said.
“We will face several years of rising nominal wages with unit labour cost pressures exacerbated by subdued productivity growth”, she added.
“My intention is not to signal any future decisions, but rather to frame the issues that monetary policy will face in the period ahead”.
She said that more companies were hoarding labour because of increased shortages of skilled workers which was reducing productivity as wages rose higher than output, putting upward pressure on inflation.
Eurozone annual inflation is expected to drop by 5.6% in June when fresh date is released on Friday – still well above the ECB’s 2% target but down from a peak of 10.6% in October as energy food prices continue to slow.
The ECB says it will continue increasing interest rates until underlying price pressures drop. Core inflation (excluding energy and food) is expected to rise from 5.3% in May to 5.5% this month.