ECB chief economist sees benefits of raising rates in ‘smaller increments’

The European Central Bank’s chief economist has said it should increase borrowing costs at a “steady pace”, casting doubt over whether he will support calls to raise interest rates by a record 0.75 percentage points next week.

Philip Lane told an event in Barcelona on Monday it would be better to “chop up” the expected path of rate rises over the coming months into “smaller increments” as this would give it time to “learn more” about how the economy is progressing.

His comments on Monday represent a mild pushback against more hawkish comments by other members of the ECB governing council, some of whom have anonymously called for it to consider a three-quarter percentage point rate rise for the first time in its history at next week’s meeting.

However, economists noted that Mr Lane, a former governor of the Irish Central Bank, left the door open to a more aggressive rate rise, while investors continued to price in a strong probability of the ECB increasing its deposit rate by a record 75 basis points next week.

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Pressure for a bigger cut came as German inflation accelerated to the most since the euro was introduced on soaring energy prices.

Consumer prices in Europe’s biggest economy, calculated under European Union harmonised standards, jumped 8.8 per cent from a year ago in August, matching the median estimate in a Bloomberg survey of analysts.

Food and energy costs led the advance, Germany’s statistics office said on Tuesday, though their impact was partially offset by temporary government aid, including a fuel rebate and ultra-cheap public transport.

On Tuesday, Slovenia’s finance minister, Bostjan Vasle, said he supported a rate increase next week that “could exceed 50 basis points, while his Dutch colleague, Klaas Knot, urged “swift and “forceful action.

The ECB raised rates for the first time since 2011 in July, lifting its deposit rate out of negative territory to zero in a bigger move than it had signalled as it sought to bring inflation back towards its 2 per cent target.

But inflation growth has consistently outstripped its forecasts and on Wednesday consumer prices are expected to set another new euro-zone record, rising to 9 per cent when the latest inflation data is published by Eurostat, driven higher by record gas prices.

Mr Lane said inflation was “extremely high” and “many people’s pay levels may not be aligned with costs, to put it mildly”, which meant “there is still some adjustment on costs to come and that is going to keep inflation high for some time”.

The ECB chief economist, one of the more dovish members of the rate-setting council, said the central bank had entered “an important new phase” after exiting negative rates in which it identifies how high it thinks rates need to go to bring inflation back to its target — the so-called terminal rate.

“A steady pace (that is neither too slow nor too fast) in closing the gap to the terminal rate is important for several reasons,” said Mr Lane. Such a “calibrated” approach to rate rises would allow markets to absorb higher borrowing costs and leave it room to target a lower terminal rate if the inflation outlook changed.

However, he did not express firm opposition to the idea of a bigger rate rise next week, saying: “The appropriate size of the individual increments will be larger the wider the gap to the terminal rate and the more skewed the risks to the inflation target.”

Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said: “Inflation is likely to deteriorate, not improve, in the next couple of months. This should keep the 75 basis point option live [for the ECB].”

“At the start of Lane’s ‘new phase’, the gap between policy rates and the neutral rate is larger by definition,” added Mr Ducrozet. “Hence I suspect he may not oppose a 75 basis point move in September.” — Copyright The Financial Times Limited 2022/Bloomberg