By Balazs Koranyi
ZAGREB (Reuters) – The European Central Bank needs to keep raising rates beyond March and must hold them at high levels for a while even as inflation falls and this “sacrifice” becomes more difficult to explain to the public, the ECB’s newest policymaker said.
Having raised rates by 3 percentage points since July, policymakers have started to ponder when and where the fastest tightening cycle in ECB history will end, especially since inflation is now retreating quickly from record highs.
But Croatian central bank Governor Boris Vujcic, whose nation joined the euro on Jan. 1, says stubborn underlying inflation means it is premature to predict the end of rate hikes and the cut priced in by markets for the turn of the year is not even worth discussing.
“We are likely to see more rate action beyond March and I would leave the issue of the terminal rate for later,” Vujcic, a career economist, university professor and Croatia’s central bank chief for the past decade told Reuters.
“Then typically you would keep the rate there for some time until you are confident that the inflation is back to where you want it to be,” he said in an interview.
Seen as a policy hawk like most governors from Europe’s former communist east, 58-year-old Vujcic has already attended ECB meetings through much of 2022 and has another year and a half left in his term.
With energy prices sharply down compared to 2022 highs and supply chains constraints easing, the ECB could cut its own inflation projections next month, Vujcic said.
And there is a possibility that price growth falls back to , one the ECB’s 2% target more quickly than now expected, he added.
GRAPHIC: Euro zone inflation expectations – https://fingfx.thomsonreuters.com/gfx/mkt/byprlknxqpe/Pasted%20image%201676018837733.png
Still, that is not a signal that the ECB’s job is done, the Croatian argued.
“There is a possibility that headline inflation will fall to 2% much sooner than expected due to various factors … (that) bring the headline figure down sharply, below core inflation,” Vujcic said.
But the ECB needs to see a sustained decline in underlying inflation, which strips out volatile food and energy prices, as this figure is a more reliable indicator of underlying price pressures and the effectiveness of monetary policy.
Dutch central bank chief Klaas Knot has also warned that headline inflation could fall below underlying prices.
This is because lower gas prices are set to drag down the overall rate quite quickly while core inflation is proving unexpectedly stubborn due to a host of factors from wages to the second-round impacts of past inflation on prices.
GRAPHIC: The race to raise rates – https://www.reuters.com/graphics/CANADA-CENBANK/zjpqjwaolvx/chart.png
The problem is that while public tends to look at headline inflation, the ECB will have to watch underlying prices as well, taking into account that the final phase of cutting inflation may be the most difficult.
“In this case, monetary policy has to be restrictive enough to push the core inflation downwards, which is not an easy task as it could imply relatively high sacrifice ratio,” Vujcic said.
Economists call sacrifice ratio the loss suffered in order to achieve a reduction in the long-run inflation rate.
It tends to be lower when inflation is coming down from high levels and usually increases in the “last mile” of disinflation, as price growth is approaching the target.
“We would have to explain to public why we are keeping restrictive monetary policy stance if headline inflation already fell,” Vujcic said.
A possible good news for the ECB is that the economy has appeared to avoid the worst of the economic downturn and prospects for a soft landing have improved.
Click here for excerpts of this interview.
(Reporting by Balazs Koranyi; Editing by Tomasz Janowski)