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Several of the European Central Bank’s more hawkish rate-setters believe that interest rates could rise again in December if wages keep increasing rapidly and inflation proves stickier than hoped.
Investors widely expect the ECB’s rate rise on Thursday, which saw the deposit rate hit 4 per cent, to be its last.
But three people involved in Thursday’s monetary policy meeting told the Financial Times that, if eurozone inflation were higher than forecast, the door was still open to raise rates again when the central bank updates its projections in December.
“I don’t agree that we are definitely done,” said one of the policymakers. “We would need a very negative surprise [on inflation] to hike again in October, but we might in December.” Another one said a quarter-point rise in December was “still possible — I’m not ruling it out”.
The central bank said on Thursday that keeping rates at their current level “for a sufficiently long duration” would make “a substantial contribution to the timely return of inflation” to its 2 per cent target. That rhetoric fuelled investor expectations that this was its final increase.
“It was spelt out more explicitly than I thought that inflation has to surprise quite a lot on the upside for them to raise again,” said Dirk Schumacher, a former ECB staff member now working as an economist at French bank Natixis.
However, the policymakers emphasised the uncertainty over how quickly price pressures would subside, especially as wage growth continues to accelerate in much of Europe — an issue flagged by ECB chief economist Philip Lane during this week’s meeting.
Lane highlighted recent deals with Dutch unions for workers to receive pay increases of at least 10 per cent. He was told about the agreements by Dutch central bank boss Klaas Knot, the policymakers said. The ECB and Knot declined to comment.
ECB president Christine Lagarde said on Thursday that the contribution of labour costs to eurozone inflation had increased during the three months to June.
Pay per employee in the eurozone rose 5.5 per cent in the second quarter from a year earlier, close to a record high. This helped to push inflation in the services sector, where labour is a large chunk of overall costs, to 5.5 per cent in August.
“A lasting rise in inflation expectations above our target, or higher than anticipated increases in wages or profit margins, could drive inflation higher, including over the medium term,” Lagarde said, adding that she could not say that rates were “at peak”.
But she also said there were early signs of companies absorbing higher wage costs by squeezing profit margins, rather than raising prices.
The ECB increased its inflation forecasts for this year and next year on Thursday, mainly on the back of higher energy prices, while it predicted that consumer price growth would only slow to its 2 per cent target by the end of 2025.
“We’ve had inflation above target for two years and we’re projecting it to stay above target for another two years, so we need to see it coming down to target in a timely way,” said one participant at this week’s meeting.
Yet the decision to increase borrowing costs for the 10th consecutive time sparked renewed ire in Italy, where prime minister Giorgia Meloni’s government has repeatedly protested against the ECB’s strategy to combat inflation.
In a television interview late on Thursday, deputy PM Matteo Salvini slammed the latest move as “the umpteenth mess made by the ECB that, without caring about the difficulties of families and businesses, raises the cost of money.”
“Lagarde lives on Mars . . . raising the cost of money is uneconomic, antisocial, anti-historical,” Salvini said.
Some investors also questioned why the ECB raised rates this week, given how the outlook for the eurozone economy has deteriorated, with Germany on the brink of a recession and both retail sales and industrial production falling across the bloc in July.
“It was a policy mistake to hike again,” said Martin Wolburg, senior economist at Generali Investments Europe. He said that the ECB’s lowered eurozone growth forecasts of 0.7 per cent this year and 1 per cent next year still looked “too optimistic” and predicted that officials would be “caught on the wrong foot” by a further slowdown in the economy later this year.
Ann-Katrin Petersen, senior investment strategist at the BlackRock Investment Institute, said that after the ECB’s “dovish hike” the focus was “now shifting from how high policy rates get, to how long they stay there”.
The ECB’s unprecedented 4.5 percentage points of rate rises since last year, coupled with a weaker Chinese economy and inventory destocking at European manufacturers “makes a recession likely in the coming quarters”, Petersen said. However, she added that this was unlikely to lead to rate cuts until “well into 2024”.