ECB officials warn of interest rates rising to record highs

European Central Bank (ECB) officials have warned that they expect to raise interest rates to record highs after euro zone inflation for February was higher than forecast, even as economists predict a rapid easing in price pressures from the summer.

Persistently high inflation, driven by stronger rises in the price of food, goods and services that are offsetting a sharp decline in energy price growth, is a worrying sign for the ECB that they may have to raise rates higher than ever before to curb price pressures.

“If we don’t get clear signals that core inflation is going down, we’ll have to do more,” Belgium’s central bank boss Pierre Wunsch, who sits on the ECB governing council, told reporters in Brussels, saying it could mean that “looking at rates of 4 per cent would not be excluded”.

Data released this week showed annual inflation in the 20-country single currency zone dipped to 8.5 per cent in February, down from 8.6 per cent in January but above economists’ predictions for a bigger fall to 8.2 per cent. Core inflation, which central bankers watch closely as it excludes energy and food prices to give a clearer picture of underlying pressures, hit a record high of 5.6 per cent last month.

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Coupled with recent US data showing upward price pressures on prices and wages, the euro zone data added to evidence that inflation is likely to stay uncomfortably high for longer than forecast, increasing workers’ calls for higher wage rises to offset soaring living costs.

“We’re going from an energy shock to another with different drivers such as salaries and fiscal policy,” said ECB vice-president Luis de Guindos, pointing to the inflationary effect of large government support measures. Headline inflation was likely to keep decelerating to below 6 per cent by mid-year, he predicted, while warning that “underlying inflation is going to be more stable”.

The ECB has raised rates by 3 percentage points since last summer. Financial markets are pricing in a jump in the bank’s deposit rate to 4 per cent later this year, up from 2.5 per cent. That would overtake the 2001 peak of 3.75 per cent.

Policymakers have said another half percentage point rate rise is almost certain at the ECB’s meeting on March 16th and several said more rises may be needed after that.

“My personal expectation is that the increase we intend for our March meeting – 0.5 percentage points – will not be the last one,” said Slovenian central bank governor Boštjan Vasle.

The biggest weekly rise in borrowing costs for euro zone governments this year was a reflection of how investors were lifting their bets on how high the ECB will raise rates. Germany’s two-year borrowing costs rose this week from 3 per cent to more than 3.2 per cent, a 14-year high.

Economists said price pressures were still likely to dissipate rapidly from this summer. “March data should be more encouraging and we still expect core inflation to come down by the summer,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management.

Sandra Phlippen, chief economist at Dutch bank ABN Amro, said services inflation could “move higher” in the first half of the year, driven up by rising wage pressure. But she said the trend should reverse by the second half “as the economic slowdown and deteriorating overall labour market conditions are expected to reduce wage growth”.

Dirk Schumacher, an economist at French bank Natixis, predicted the ECB would cut its inflation forecast for the first time in over two years when it publishes new predictions in two weeks’ time.

“I am quite convinced that inflation will be lower in three months – including core. I am obviously a lot less sure by how much,” he said, pointing out that energy prices have fallen sharply, supply chain pressures are abating, consumer spending looks set to weaken and wage growth remained relatively contained.

Anna Titareva, economist at UBS, said the Swiss bank’s euro zone pay tracker showed wage growth had picked up to 3.4 per cent in the year to January, up from 3.2 per cent the previous month “with a risk of further acceleration”. But she predicted inflation in the bloc would still fall from 5.3 per cent this year to 2.3 per cent next year, before finally hitting the ECB’s 2 per cent target in 2025. – Copyright The Financial Times Limited 2023