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Christine Lagarde has called for “persistent” interest rate rises by the European Central Bank to avoid prices staying above its target as a result of tight labour markets and a big increase in eurozone wages.
The ECB president told its annual conference in Sintra, Portugal, that the eurozone had been hit by “overlapping inflationary shocks since the end of the pandemic”. By raising its benchmark interest rate from minus 0.5 per cent last year to 3.5 per cent this month, she said the ECB had “made significant progress” in addressing high inflation but it “cannot declare victory yet”.
Lagarde said the initial phase of inflation, in which the cost of supply shocks in energy and other commodity markets was passed on to consumers by companies, was fading. But a second phase driven by rising labour costs had emerged, with eurozone wages forecast to climb 14 per cent by 2025.
“We will face several years of rising nominal wages, with unit labour cost pressures exacerbated by subdued productivity growth,” she added.
Uncertainty over how these factors would affect prices was likely to prevent the ECB from knowing when borrowing costs would peak, though it has said a further quarter-point rise is “very likely” in July. “Under these conditions, it is unlikely that in the near future the central bank will be able to state with full confidence that peak rates have been reached,” Lagarde said.
“My intention is not to signal any future decisions, but rather to frame the issues that monetary policy will face in the period ahead.”
More companies are hoarding labour because of increased shortages of skilled workers, which Lagarde said was reducing productivity, as wages rise faster than output, putting upward pressure on inflation. Eurozone unemployment fell to a record low of 6.5 per cent in April.
Eurozone annual inflation is expected to drop to 5.6 per cent in June when fresh price data is released on Friday — still well above the ECB’s 2 per cent target but down from a peak of 10.6 per cent in October as energy and food prices continue to slow.
But the ECB has said it will keep raising rates until underlying price pressures are clearly dropping: core inflation — excluding energy and food — is expected to rise from 5.3 per cent last month to 5.5 per cent this month.
The ECB expects companies’ profit margins to fall because of rising labour costs. But if they avoid a quarter of these margin losses it would keep inflation at almost 3 per cent in 2025, Lagarde estimated. “While we do not currently see a wage-price spiral or a de-anchoring of expectations, the longer inflation remains above target, the greater such risks become.”
Because the ECB has never lifted interest rates as much or as swiftly as it has in the past year, Lagarde said there was uncertainty about when these higher borrowing costs would feed through to consistently lower price pressures.
Lagarde said the ECB would need to commit to keeping rates high for as long as necessary to ensure inflation falls. “This will ensure that hiking rates does not elicit expectations of a too-rapid policy reversal and will allow the full impact of our past actions to materialise.”
Goldman Sachs analysts said in a note to clients that Lagarde’s “fairly hawkish” comments suggested there could still be some “distance until the ECB reaches its peak rate”, adding: “Rather than viewing weaker growth as exacerbating the policy trade-off, the ECB sees it as the means by which inflation will come down.”
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