The Chief Economist of the European Central Bank (ECB), Philip Lane, has cautioned markets against anticipating interest rate cuts in the next two years. Despite the ECB’s recent 25 basis point increase in its main rate to 3.5%, Lane emphasized the need for restrictive policies to combat record-high inflation in the euro zone.
In May, headline inflation in the euro zone stood at 6.1% annually, a slight decrease from the previous month’s 7%. Core inflation, which excludes volatile food and energy prices, remained at 5.3% year on year, significantly above the ECB’s target of 2%. Lane, speaking at the Sintra central bank meeting in Portugal, described the euro zone economy as being in an “adjustment phase.” He highlighted the impact of higher interest rates and the struggle of wages to catch up with rising prices.
Lane encouraged the market to question the timing and pace of policy reversal. He stated that it would take a couple of years for inflation to reach the desired 2% level. Although progress is expected this year, especially in the latter part, a rapid decline to 2% within a few months is unlikely.
These remarks by Lane echo the sentiments expressed by Christine Lagarde, the President of the ECB. Lagarde acknowledged the “significant progress” made by the central bank but emphasized that victory cannot be claimed just yet.
Since July 2022, the ECB has raised rates by 400 basis points. The market has already factored in a 25 basis point increase for next month and is contemplating an additional hike in September. However, some economists have suggested that the ECB may need to reverse its monetary tightening if higher rates begin to hinder the euro zone economy.
In contrast, the U.S. Federal Reserve recently decided to pause its rate hiking cycle, leaving its target rate unchanged. It took a hawkish stance by hinting at two more rate increases later this year.
Lane stressed that policymakers must remain committed to restrictive monetary conditions for an extended period. This approach is necessary to prevent any new shocks from diverting the inflation rate from the target of 2%. Lane emphasized the importance of the durability of restrictiveness in maintaining stability.
Looking ahead, Lane does not anticipate rapid rate cuts in the next couple of years. Therefore, he believes it is inappropriate for the market to expect such cuts in the near future.
In summary, the European Central Bank is warning against premature expectations of interest rate cuts. With the euro zone economy in an adjustment phase, the ECB aims to tackle high inflation through restrictive policies. While progress is expected, it will take time before inflation reaches the desired target. The ECB intends to maintain restrictive monetary conditions to ensure stability and prevent any new shocks. Rapid rate cuts are unlikely in the foreseeable future, according to the Chief Economist of the ECB.